Risk Aversion, Performance Pay, and the Principal-Agent Problem

Joseph Gerard Haubrich

349 citations0/0 files storedJournal of Political Economy

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Corporate Finance and Governance Accounting and Organizational Management Auction Theory and Applications

Abstract

This paper calculates numerical solutions to the principal-agent problem and compares the results to the stylized facts of CEO compensation. The numerical predictions come from parameterizing the models of Grossman and Hart and of Holmstrom and Milgrom. While the correct incentives for a CEO can greatly enhance a firm's performance, providing such incentives need not be expensive. For many parameter values, CEO compensation need increase only by about $10 for every $1,000 of additional shareholder value; for some values, the amount is 0.003 cents.

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References

1990Performance Pay and Top-Management Incentives 1971An Exploration in the Theory of Optimum Income Taxation 1988Outside directors and CEO turnover 1987Aggregation and Linearity in the Provision of Intertemporal Incentives 1983An Analysis of the Principal-Agent Problem 1992An Analysis of the Principal-Agent Problem 1988Compensation and Incentives: Practice vs. Theory 1977THE DEMAND FOR RISKY ASSETS

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