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 limited liability. We show that -- contrary to the informativeness principle -- informative signals may have no value, because the payment cannot be adjusted to reflect the signal realization.

We derive necessary and sufficient conditions for a signal to have value under limited liability, and study how valuable signals should be incorporated into the contract. Our results have implications for performance-sensitive debt, pay-for-luck, option repricing, and performance-based vesting. For example, it may be optimal for more options to vest upon a negative signal of effort.

Authors

Real name: 
Pierre Chaigneau
Real name: 
Daniel Gottlieb