Garrett, Daniel F. and Pavan, Alessandro (2015) Dynamic Managerial Compensation: A Variational Approach. Journal of Economic Theory, 159. pp. 775-818.

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Identification Number : 10.1016/j.jet.2015.04.004


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.

Item Type: Article
Language: English
Date: September 2015
Refereed: Yes
Uncontrolled Keywords: managerial compensation, incentives, pay for performance, dynamic mechanism design, adverse selection, moral hazard, persistent productivity shocks, risk aversion, wedges, variational approach, first-order approach
Divisions: TSE-R (Toulouse)
Site: UT1
Date Deposited: 31 May 2016 14:21
Last Modified: 27 Oct 2021 13:36
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