The Value of Performance Signals Under Contracting Constraints

The Value of Performance Signals Under Contracting Constraints

Pierre Chaigneau, Alex Edmans, Daniel Gottlieb

Series number :

Serial Number: 
439/2014

Date posted :

September 01 2014

Last revised :

February 01 2018
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Keywords

  • Informativeness principle • 
  • contract theory • 
  • principal-agent model • 
  • Limited Liability • 
  • pay-for-luck • 
  • relative performance evaluation • 
  • options

This paper studies the value of additional performance signals under contract- ing constraints, such as limited liability, monotonicity, or upper bounds to pay or incentives. We show that - contrary to the informativeness principle - infor- mative signals may have no value, because the payment cannot be adjusted to re ect the signal realization.

We derive necessary and suf cient conditions for a signal to have value under such constraints, and study how valuable signals should be incorporated into the contract. Our results have implications for perfor- mance-based vesting, option repricing, pay-for-luck, and performance-sensitive debt. For example, it may be optimal to lower the strike price of an option upon a negative signal of effort.

Authors

Real name: 
Pierre Chaigneau
Real name: 
Daniel Gottlieb