Optimal compensation contracts under asymmetric information concerning expected earnings
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Authors
Miglo, Anton
Issue Date
2007-01-10
Type
Article
Language
en_US
Keywords
Business , Optimal compensation , Asymmetric information , Annual bonus , Stock options
Alternative Title
Abstract
We analyze a model with two-dimensional asymmetric information where the employer has better information about the firm’s earnings potential and the employee is subject to moral hazard. The employee’s contract consists of an annual bonus and stock options. We focus on two issues: how different degrees of asymmetric information about short-term earnings versus long-term earnings affect optimal contracts and second, if a signalling equilibrium exists, what information concerning the firm’s performance profile over time can be conveyed by the choice of contract. We show that if the extent of long-term (short-term) asymmetric information is larger, short-term (long-term) compensation prevails. With regard to signalling, we show that firms offering more options have higher short-term performance and lower long-term performance. This provides new insights into the structure of earnings-based compensation. For example, this is consistent with evidence that stock options are inversely related to the timeliness of accounting numbers or to the extent to which current earnings incorporate value-relevant information and that firms issuing stock options for employees outperform other firms shortly after the issue while there is no significant difference in the long run.
Description
Citation
Miglo, A. (2007, January 10). Optimal compensation contracts under asymmetric information concerning expected earnings.