European Finance Association
Milan, Italy | August 25-27, 2021
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CFT 03: Organizing Groups
Private Compensation and Organizational Design
1University of Colorado Boulder; 2City University of Hong Kong; 3Boston University
Most of the literature on organizational design and incentives assumes public contracting. Yet most real world compensation contracts are private information, observed only by their direct signatories. This matters when agents work together to produce a joint output, because they care about each others' incentives. In this case, the principal can gain from designating one agent ``team leader,'' with authority to decide, and hence observe, all the bonuses. Such ``outsourcing'' of contracting is never optimal with fully public contracts. With private contracts, by contrast, it raises effort by reassuring agents that the incentives provided are sufficiently strong; but it distorts effort allocation, as the team leader takes too much of the compensation budget. Even when observability is held constant, pay delegation can raise output by skewing bonuses towards more productive agents.
Uncertainty and Contracting in Organizations
1University of North Carolina Chapel Hill, United States of America; 2Baylor University
We examine a multidivisional firm with headquarters exposed to moral hazard by division managers under uncertainty. We show the aggregation and linearity properties of Holmström and Milgrom (1987) hold under IID ambiguity of Chen and Epstein (2002). Due to uncertainty aversion,
agents' beliefs depend endogenously on their exposure to uncertainty, either for their position in the organization (hierarchical exposure) or contracts (contractual exposure). Incentive contracts, by loading primarily on division cash-flow, lead division managers to be more conservative than
headquarters, aggravating moral-hazard. By hedging uncertainty, headquarters design contracts that reduce disagreement, lower incentive provision costs, promoting e¤ort. Because hedging uncertainty interacts with hedging risk, optimal contracts differ from those in standard principal-
agent models. Our model helps explain the prevalence of equity-based incentive contracts and the rarity of relative-performance compensation.
Corporate governance in the presence of active and passive delegated investment
1University of Michigan, United States of America; 2Cornell University, United States of America
We examine the governance role of delegated portfolio managers. In our model, investors allocate their wealth between passive funds, active funds, and private savings, and fund fees are endogenously determined. Funds' ownership stakes and fees determine funds' incentives to engage in governance. Whether passive fund growth improves governance depends on whether it crowds out private savings or active funds. In the former case, it improves governance even though it is accompanied by lower fees, whereas in the latter case it can harm governance. Overall, passive fund growth improves governance only if it does not increase fund investors' returns too much.
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