Handout 3B - Managerial Incentives and Corporate Governance...

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Managerial Incentives and Corporate Governance Tirole (2001, Section 2): Principal-Agent Model Assumptions: (1)The entrepreneur (EN) is risk neutral, so are the investors. (2)The entrepreneur (EN) either works or shirks. (Two effort levels) (3)The entrepreneur (EN) has an inside equity A, borrows from a competitive capital market. The probability of success depends on EN’s effort, which is unobservable. (Moral hazard as in Holmstrom(1979) ) Corporate Finance © Professor Ho-Mou Wu 3B-1 Spring 2004
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Shareholder Value: Managerial Incentive The probability of success is if EN works. If EN shirks, the probability of success is and EN enjoys a private benefit B. EN borrows from investors, and chooses effort level. If the outcome is success, the verifiable profit is R. Otherwise, the profit if zero. Assume that NPV is positive if the investors can induce EN to work: The incentive contract gives EN a compensation of W in case of success and zero otherwise. The “incentive compatibility” constraint is
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This note was uploaded on 01/23/2011 for the course FGB 780 taught by Professor Edwardchang during the Spring '09 term at Missouri State University-Springfield.

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Handout 3B - Managerial Incentives and Corporate Governance...

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