CEOs are routinely compensated for aspects of firm performance that are beyond their control. This is puzzling from an agency perspective, which assumes performance pay should be efficient. Working within an agency framework, we provide a rational for this seemingly inefficient feature of CEO compensation by invoking the idea of informal agreements, specifically the theory of relational contracting. We derive observable implications to distinguish relational from formal contracting and, using ExecuComp data, find that CEOs' annual cash and equity incentive payments positively correlate with the cyclical component of sales and respond to measures of persistence as relational contracting theory predicts.
This paper investigates a repeated employment relationship between a principal and agents who he hires to solve a series of problems. Each agent works independently, but the principal can choose to pay a team incentive bonus to all agents if any one of them solves a problem. We show that, under relational contracts, there is a range of parameter values for which the principal prefers team incentives to individual incentives. Team incentives create a problem of moral hazard, but they can also reduce the principal's commitment problem by smoothing bonus payments over time. The latter effect is particularly strong when problems are difficult to solve. If team size is endogenous, team incentives can increase efficiency by allowing the principal to motivate a greater number of agents. However, in some such cases, the principal still chooses individual incentives because they allow him to appropriate more surplus. (JEL J41, M52
This paper examines the optimal sequencing of sales in the presence of network externalities. A firm sells a good to a group of consumers whose payoff from buying is increasing in total quantity sold. The firm selects the order to serve consumers so as to maximize expected sales. It can serve all consumers simultaneously, serve them all sequentially, or employ any intermediate scheme. We show that the optimal sales scheme is purely sequential, where each consumer observes all previous sales before choosing whether to buy himself. A sequential scheme maximizes the amount of information available to consumers, allowing success to breed success. Failure can also breed failure, but this is made less likely by consumers' desire to influence one another's behavior. We show that when consumers differ in the weight they place on the network externality, the firm would like to serve consumers with lower weights first. Our results suggests that a firm launching a new product should first target independent-minded consumers who can serve as opinion leaders for those who follow.
JEL-codes: M31, D42, D82, L12
This study investigates the structure of optimal incentives in a stochastic environment and provides evidence for the use of self-enforcing relational contracts. We show theoretically that under relational contracting, firms can credibly promise chief executive officers (CEOs) larger bonuses in good states than in bad, in a way that depends crucially on the state's persistence and the firm's discount factor. Formal contracting instead implies the same bonus in both states. Estimating an empirical model using ExecuComp data, we find that CEO annual bonuses are related to "luck" in a manner consistent with relational contracting.
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