Option-Like Contracts for Innovation and Production
45 Pages Posted: 15 Feb 2000
Date Written: January 2000
Abstract
We model how firms motivate their risk-averse managers to evaluate new investment projects as well as to manage assets-in-place. We first consider a two-agent model: an Innovator in charge of project adoption and a Producer in charge of production. The Innovator's effort produces better information on risky projects, but he may reject a good project in order to avoid risk. The Producer's effort increases the mean of firm value but he faces uncertainty in his productivity, due to the externality created by the new project. We examine the two agents' roles in the firm separately and also combine them in a Nash game. We derive optimal contracts for them and show that under mild conditions they exhibit convexity. We next demonstrate that when a single agent is assigned both tasks, his contract is in general convex, with the degree of convexity increasing in the agent's importance in managing the new project. We interpret the convexity in the optimal contracts as "option-like" compensation.
JEL Classification: G33 to G31
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Are CEOS Really Paid Like Bureaucrats?
By Brian J. Hall and Jeffrey B. Liebman
-
Are CEOS Really Paid Like Bureaucrats?
By Brian J. Hall and Jeffrey B. Liebman
-
The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation
-
Good Timing: CEO Stock Option Awards and Company News Announcements
-
Good Timing: CEO Stock Option Awards and Company News Announcements
-
The Use of Equity Grants to Manage Optimal Equity Incentive Levels
By John E. Core and Wayne R. Guay
-
The Other Side of the Tradeoff: the Impact of Risk on Executive Compensation
-
Stock Options for Undiversified Executives
By Brian J. Hall and Kevin J. Murphy