Working Papers

Informing Adaptation under Booms and Busts

Leading employees to adapt to changing market conditions -- e.g., increased competition or technological change -- is an important concern for managers in many business situations. Insufficient adaptation may arise either because employees do not have the information necessary to adapt or because they are not sufficiently incentivized. This paper considers a contracting problem in which a principal is privately informed of market conditions and wants to induce an agent to choose the project that best fits these conditions. The contract plays a dual role in both motivating and informing the agent. Here, the principal faces a trade-off: A contract that reveals the market conditions fosters adaptation, but it may demotivate the agent. In a dynamic setting, the equilibrium contracts never fully reveal the market conditions, ultimately resulting in insufficient adaptation. When market conditions are stable, adaptation is inefficiently delayed. However, when market conditions are volatile, the optimal contract induces early adaptation. In both cases, the equilibrium exhibits organizational inertia and path-dependence: There is a bias towards continuing old projects.

Boards and Information: Evidence from Stock Returns after Subjective Performance Reviews

with Moqi Groen-Xu and Peggy Huang

This paper studies the information content of board decisions using the setting of CEO subjective performance reviews. We find evidence that positive subjective reviews predict long-term stock returns. A long–short portfolio strategy that invests in firms with positive reviews earns abnormal returns of 6%–8% annually. Positive reviews also predict more announcements of new product developments and greater abnormal returns around these announcements. Our measure of positive subjective reviews is based on salary changes, a commonly used reward for such reviews, as we show with content from ex-ante contracts as well as ex-post compensation narratives. Our results suggest that boards on average use valid soft information in the interest of shareholders.


Explaining Downward-rigid CEO Compensation: An Information Asymmetry Perspective

CEO compensation rarely gets cut, and almost every component of it increased in early 2000. I consider a two-period contracting problem in which a board privately knows its CEO's matching quality with the firm that changes over time. The board faces a trade-off: Revealing good information makes the CEO work harder, but it is costly. To save the information revelation cost, the board commits to a back-loaded compensation plan that features only upward adjustments in fixed and performance-based pay. This paper also considers extensions in which CEOs have transferable skills and sheds light on bonus caps and compensation disclosure policies.