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Manchester Grand Hyatt, Seaport B
American Finance Association
Contracts and Incentives
Friday, Jan. 3, 2020 8:00 AM - 10:00 AM (PDT)
- Chair: Alex Edmans, London Business School
Uncertainty and Contracting: A Theory of Consensus and Envy in Organizations
AbstractA key issue for the design of incentive contracts is whether firms should use incentive contracts based on overall equity performance, or contracts where pay is based on division-specific performance. The distinction between equity-based contracts and division-specific pay, such as pay-for-performance compensation, is particularly important for lower-level managers. The case for equity-based contracts for top managers is rather strong, as they are responsible for the performance of the overall firm. More puzzling is the widespread use of equity-based compensation for division and rank-and-file managers who are deeper down in an organization. This is because, for such lower-level managers, equity-based contracts reduce the responsiveness of their pay to their actions, thus "diluting" their incentives. Our paper proposes a novel explanation of the optimal incentive contracts in organizations based on uncertainty aversion (or "Knightian" uncertainty) within a multi-layered firm. We study a setting where, absent uncertainty, division managers should be paid based on their division performance, but not other divisions' performance. As uncertainty increases, division managers become more conservative (than company headquarters) about the prospects of their own division, diminishing effort. Correspondingly, division managers become also relatively more positive about the prospects of others divisions within the firm, generating envy and discord in the organization. When uncertainty is large enough, headquarters grants a division manager a share of other divisions' payoff to hedge uncertainty, thus instilling confidence and promoting a shared view (i.e., consensus) within the organization. Our model can explain the prevalence of equity-based incentive contracts in (young) firms with uncertain cash-flow prospects, and the prevalence of performance-based contracts in more mature and well established firms.
Executive Mobility in the United States, 1920 to 2011
AbstractWe examine the evolution of executive mobility and its implications for corporate decisions from 1920-2011. We find that in the eight decades leading up to 2001 (1) movements of executives to new executive positions became more common; (2) executives moved across an increasingly diverse set of industries; and (3) conditional on moving, executives moved to larger, more profitable, and higher-paying firms, even more so in recent decades. However, many of these trends reversed starting in the early-2000s. Exploiting these mobility trends, we hypothesize that improved mobility for executives mitigates incentive problems. Using CEO deaths in connected industries as an instrument for mobility, we find that increased mobility leads to lower pay-for-performance sensitivity, board monitoring, and financial leverage, and higher corporate investment. Our findings are consistent with predictions of career concern and dynamic agency models that implicit incentives from the labor market reduce the need for explicit incentives and monitoring.
Choose Your Battles Wisely: The Consequences of Protesting Government Procurement Contracts
AbstractFirms that successfully protest a government agency’s conduct or terms of a procurement contract lose future business opportunities with the government. Their chance of receiving procurement contracts from the contested government agencies during the following four years drops by 68%, and they experience significant reductions in sales growth and employee growth. They receive fewer contracts also from other, non-contested, government agencies. Despite widespread belief, successful bid protestors do not delay the government procurement process due to lengthy dispute resolutions. Overall, we provide the first analysis of how firms interact with the government bid-protest system in the United States. Our results demonstrate the consequences of legitimate bid protests on firms and raise questions about the efficacy of the government bid-protest system.
University of Southern California
Imperial College London
University of Washington
- G3 - Corporate Finance and Governance