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- Title
Ambiguity sharing and the lack of relative performance evaluation.
- Authors
Wu, Yaoyao; Yang, Jinqiang; Zou, Zhentao
- Abstract
We extend the Holmstrom and Milgrom (Econometrica 55:303-328, <xref>1987</xref>) model by introducing model uncertainty to study robust long-term contracting and focus on relative performance evaluation. Concerns regarding model misspecification induce a tradeoff between incentives and ambiguity sharing, which increases the pay-performance sensitivity. When compensation contracts can be written on some additional signal, such as industry average performance, we find that an ambiguity-averse principal increases the agent’s exposure to the common shock by reducing the use of relative performance evaluation. Thus, optimal contracting involves effectively paying for luck and our model provides a theoretical explanation for the well-documented lack of relative performance evaluation in CEO compensation from the perspective of model uncertainty.
- Subjects
PERFORMANCE evaluation; CONTRACTING out; LABOR incentives; EXECUTIVE compensation; CHIEF executive officers; ECONOMIC shock
- Publication
Economic Theory, 2018, Vol 66, Issue 1, p141
- ISSN
0938-2259
- Publication type
Article
- DOI
10.1007/s00199-017-1056-x