Dynamic managerial compensation: A variational approach

Daniel Garrett and Alessandro Pavan

Journal of Economic Theory, 2015, vol. 159, issue PB, 775-818

Abstract: We study the optimal dynamics of incentives for a manager whose ability to generate cash flows changes stochastically with time and is his private information. We show that distortions (aka, wedges) under optimal contracts may either increase or decrease over time. In particular, when the manager's risk aversion and ability persistence are small, distortions decrease, on average, over time. For sufficiently high degrees of risk aversion and ability persistence, instead, distortions increase, on average, with tenure. Our results follow from a novel variational approach that permits us to tackle directly the “full program,” thus bypassing some of the difficulties of the “first-order approach” encountered in the dynamic mechanism design literature.

Keywords: Incentives; Dynamic mechanism design; Adverse selection; Moral hazard; Persistent productivity shocks; Risk aversion (search for similar items in EconPapers)
JEL-codes: D82 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:159:y:2015:i:pb:p:775-818

DOI: 10.1016/j.jet.2015.04.004

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