Adverse selection, contract design and investment distortion

Noe, Thomas and Rebello, Michael (1992) Adverse selection, contract design and investment distortion. Journal of Financial Intermediation, 2 (4). pp. 347-375.

Abstract

We examine the design of compensation contracts and determination of investment policies when a manager has private information regarding the effect of investment on both the firm's cash flows and the private benefits she is able to extract from employment. We show that, in general, the optimal mechanism is characterized by a menu of salary and option contracts. When the manager's private information relates only to the firm's cash flows, the firm overinvests relative to the Pareto optimal level. On the other hand, if the private information relates only to private benefits, the firm will underinvest.

Item Type: Article
Keywords: investments; compensation; finance
Subject(s): Finance
Date Deposited: 17 Nov 2011 12:50
Last Modified: 02 Mar 2017 11:01
Funders: N/A
URI: http://eureka.sbs.ox.ac.uk/id/eprint/1151

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