Working Papers
Working Papers
June 2008
Abstract
We reexamine the issue of executive compensation within a general equilibrium production context. Intertemporal optimality places strong restrictions on the form of a representative manager's compensation contract, restrictions that appear to be incompatible with the fact that the bulk of many high-profile managers'
compensation is in the form of various options and option-like rewards. We therefore measure the extent to which a convex contract alone can induce the manager to adopt near-optimal investment and hiring decisions. To ask this question is essentially to ask if such contracts can effectively align the stochastic discount factor of
the manager with that of the shareholder-workers. We detail exact circumstances under which this alignment is possible and when it is not.
Executive Compensation: A General Equilibrium Perspective, with J.B. Donaldson
New version - May 2008
Abstract
We
study the dynamic general equilibrium of an economy where risk averse
shareholders delegate the management of the firm to risk averse
managers. The optimal contract has two main components: an
incentive
component corresponding to a non-tradable equity position and a
variable 'salary' component indexed to the aggregate wage bill and to
aggregate dividends. Tying a manager's compensation to the
performance
of her own firm ensures that her interests are aligned with the goals
of firm owners and that maximizing the discounted sum of future
dividends will be her objective. Linking managers'
compensation to
overall economic performance is also required to make sure that
managers use the appropriate stochastic discount factor to value those
future dividends. General equilibrium considerations thus provide a
natural resolution to the 'pay for luck' puzzle. We also demonstrate
that one sided 'relative performance evaluation' follows equally
naturally when managers and shareholders are differentially risk averse.
The Business Cycle Implications of Reciprocity in Labor Relations, with A. Kurmann
November 2007
Abstract
We develop a reciprocity-based
model of wage determination and incorporate it into a modern dynamic general
equilibrium framework. We estimate the model and find that, among potential
determinants of wage policy, rent-sharing (between workers and firms)
and a
measure of wage entitlement are critical to fit the dynamic responses
of hours, wages and inflation to various exogenous shocks. Aggregate employment
conditions (measuring workers' outside option), on the other hand, are
found to play only a negligible role in wage setting. These results are
broadly consistent with micro-studies on reciprocity in labor relations
but contrast with traditional efficiency wage models which emphasize aggregate
labor market variables as the main determinant of wage setting. Overall,
the empirical fit of the estimated model is at least as good as the fit
of models postulating nominal wage contracts. In particular, the reciprocity
model is more successful in generating the sharp and significant fall
of inflation and nominal wage growth in response to a neutral technology
shock.
Appendix to The Business Cycle Implications of Reciprocity in Labor relations
