Does Improved Information Improve Incentives?

Does Improved Information Improve Incentives?

Pierre Chaigneau, Alex Edmans, Daniel Gottlieb

Series number :

Serial Number: 
442/2014

Date posted :

September 01 2014

Last revised :

October 17 2018
SSRN Share

Keywords

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

This paper studies the value of more precise signals on agent performance in an optimal contracting model with endogenous effort. With limited liability, the agent's wage is increasing in output only if output exceeds a threshold, else it is zero regardless of output.

If the threshold is sufficiently high, the agent only beats it, and is rewarded for increasing output through greater effort, if there is a high noise realization. Thus, a fall in output volatility reduces effort incentives -- information and effort are substitutes -- offsetting the standard effect that improved information lowers the cost of compensation. We derive conditions relating the incentive effect to the underlying parameters of the agency problem.

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Published in

Published in: 
Publication Title: 
Journal of Financial Economics
Description: 
Volume 130, Issue 2, November 2018, Pages 291-307

Authors

Real name:
Pierre Chaigneau
Real name:
Daniel Gottlieb