Respondable risk and incentives for CEOs: The role of information-collection and decision-making

This paper examines the incentive provision when the agent can respond to risk by exerting effort to collect information about the underlying state and making corresponding decisions. Such effort is shown to be more valuable in a riskier environment and incentives can increase with “respondable” risk. The relation between incentives and risk is more positive when the agent's effort is more effective in collecting information or in acting upon it. Using data on chief executive officers (CEOs), I find that incentives for CEOs increase with industry-wide risk, a measure of respondable risk. The positive relation diminishes when the CEO is less able to collect information or is less effective in acting upon it.     

Delegation and incentives

This article analyzes the relation between authority and incentives. It extends the standard principal‐agent model by a project selection stage in which the principal can either delegate the choice of project to the agent or keep the authority. The agent's subsequent choice of effort depends both on monetary incentives and the selected project. We find that the consideration of effort incentives makes the principal less likely to delegate the authority over projects to the agent. In fact, if the agent is protected by limited liability, delegation is never optimal.     

Incentives and invention in universities

We show that universities in the United States that provide stronger royalty incentives to faculty scientists generate greater license income, controlling for university characteristics. We use pre‐sample data on university patenting to control for the potential endogeneity of royalty shares. Faculty responds to royalties both in the form of cash and research lab support, indicating both pecuniary and intrinsic research motivations. The impact of incentives is larger in private than in public universities, and we provide new survey evidence on the organization and objectives of university licensing offices to explain this difference. Royalty incentives work both by raising faculty effort and sorting scientists across universities. The primary impact of incentives is to increase the quality rather than the quantity of inventions.     

The role of government in the venture capital market with asymmetric information

Information asymmetry increases the risks undertaken by venture capitalists. The present study departs from the tendency in earlier analyses to attribute the problem of information asymmetry to the entrepreneur only. In view of the obvious social benefits that the development of the venture capital industry brings, the government should take upon itself to consider tax incentives and changes to regulatory policies in order to attract venture capital investments. Three scenarios are portrayed here to examine the issue of asymmetric information in the venture capital market: (1) when both the venture capitalist's and entrepreneur's efforts are observable and the government incentive policy is available; (2) when the entrepreneur's effort is unobservable but the venture capitalist's is observable and government tax incentive is available; and (3) when the entrepreneur's effort is observable but the venture capitalist's effort is unobservable, and regulatory monitoring and government tax incentives are uncertain. This investigation reveals that the tax incentive policy and regulatory measures put in place by the government can significantly and positively affect the outcome of the entrepreneurial project by reducing information asymmetry.     

Analyst Coverage and Intangible Assets

This study examines the relation between analysts' incentives to cover firms and the extent of their intangible assets. Because intangible assets typically are unrecognized and estimates of their fair values are not disclosed, absent analyst coverage firms with more intangible assets likely have less informative prices. Accordingly, we expect analysts have greater incentives to cover firms with more intangible assets and, thus, predict they have higher analyst coverage. As predicted, we find that analyst coverage is significantly greater for firms with larger research and development and advertising expenses relative to their industry, and for firms in industries with larger research and development expense. We also predict and find that analyst coverage is increasing in firm size, growth, trading volume, equity issuance, and perceived mispricing, and is decreasing in the size of the firm's analysts' brokerage houses and the effort analysts expend to follow the firm. These findings indicate that analyst coverage depends on private benefits and costs of covering a firm. We also test hypotheses related to analyst effort. We predict and find that analysts expend greater effort to follow firms with more intangible assets, after controlling for other factors associated with analyst effort. Our evidence indicates that intangible assets, most of which are not recognized in firms' financial statements, are associated with greater incentives for analysts to cover such firms, and greater costs of coverage. An open question is whether financial statement recognition of intangible assets could more efficiently provide information about such assets to investors.     

Optimal strike prices of stock options for effort-averse executives

This paper evaluates the common practice of setting the strike prices of executive option plans at-the-money. Hall and Murphy [Hall, Brian, Murphy, Kevin J., 2000. Optimal exercise prices for executive stock options. American Economic Review 90 (2), 209–214] claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance. However, they do not incorporate effort and the possibility that managers are effort-averse into their model. We revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages, options, and stock grants. We simulate the manager’s effort choice and compensation as well as the value of shareholders’ equity under alternative compensation schemes, and identify schemes that are optimal. Our simulations indicate that, when abstracting from tax considerations, it is optimal to award managers with options that will most likely be highly valuable (i.e., substantially in-the-money) on their expiration date. Prior to 2006, the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations. Recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006.     

Financing and Advising: Optimal Financial Contracts with Venture Capitalists

This paper analyses the joint provision of effort by an entrepreneur and by an advisor to improve the productivity of an investment project. Without moral hazard, it is optimal that both exert effort. With moral hazard, if the entrepreneur's effort is more efficient (less costly) than the advisor's effort, the latter is not hired if she does not provide funds. Outside financing arises endogenously. This explains why investors like venture capitalists are value enhancing. The level of outside financing determines whether common stocks or convertible bonds should be issued in response to incentives.     

Managerial incentives,options, and cost-structure choices

This study explores the relationship between changes in managerial risk-taking incentives and adjustments of firms’ cost structures, particularly the operating leverage (fixed-to-variable cost ratio). We find managers reduce operating leverage by substituting fixed costs with variable costs, mainly in the selling, general, and administrative (SG&A) and research and development (R&D) cost components, in response to reductions in option-based compensation following the issuance of FAS 123R. Managers facing a decrease in risk-taking incentives adjust operating leverage downward because high operating leverage intensifies the downside potential of earnings. Overall, we present compelling evidence that managers adjust the cost structure of their firms in response to a reduction in risk-taking incentives.     

Health care : Planning, policies, and incentives

In theory, health planning is a detailed and rational corporate attempt to handle broad social problems. But in practice it tends to be incremental—an institutionalised bargaining system which too often neglects the larger issues in favour of marginal adjustments. Mixed scanning, the detailed examination of selected, feasible proposals, combines the best features from theory and practice. Implementation still depends on the recognition of powerful interest groups (eg doctors, managers) and the inclusion of incentives to redirect their activities. Better planning does not guarantee better health—the influence of lifestyle and environment must not be neglected.     

Medical Labour Supply and the Production of Healthcare

Medical labour markets are important because of their size and the importance of medical labour in the production of healthcare and in subsequent patient outcomes. We present a summary of important trends in the UK medical labour market, and we review the latest research on factors that determine medical labour supply and the impact of labour on patient outcomes. The topics examined include: the responsiveness of labour supply to changes in wages, regulation and other incentives; factors that determine the wide variation in physician practice and style; and the effect of teams and management quality on patient outcomes. This literature reveals that while labour supply is relatively unresponsive to changes in wages, medical personnel do react strongly to other incentives, even in the short run. This is likely to have consequences for the quality of care provided to patients. We set out a series of unanswered questions in the UK setting, including: the importance of non‐financial incentives in recruiting and retaining medical staff; how individuals can be incentivised to work in particular specialties and regions; and how medical teams can be best organised to improve care.     

Audit Committee Members’ Reputation Incentives and Their Effectiveness in Monitoring the Financial Reporting Process

We examine whether the reputation incentives of audit committee members are associated with their effectiveness in monitoring the financial reporting process. Prior research assumes that audit committee members allocate their effort proportionately across all memberships on which they serve. However, our findings suggest that audit committee members with multiple audit committee memberships tend to focus their attention on the memberships that provide them with the greatest reputation incentives. Specifically, firms with a larger proportion of audit committee members where the membership is the most prominent are associated with higher financial reporting quality and more effective monitoring of internal control. Additional tests reveal that audit committee members’ reputation incentives are driving our results rather than independent non-audit committee members’ reputation incentives. We conclude that reputation is a strong incentive for audit committee members, such that it influences their monitoring effectiveness over the financial reporting process.     

A note on the interaction effects of non-financial measures of performance

Using principal-agent analyses, the effect of the interactions between two non-financial measures of performance in an agent’s incentive compensation scheme is studied. The agent can allocate effort between “meeting output targets” and “getting output that needs no rework.” The principal trades off (1) a penalty for not meeting output targets, and (2) cost of reworking output that is defective when initially produced. In a compensation mechanism that includes incentives based on measures of output that needs no rework, as well as total output, it is shown that the agent may respond to an increased weight on output that needs no rework by reducing effort allocated towards it. This occurs when the increased weight on the output that needs no rework is accompanied by a sufficiently steep decrease in the weight on total output in the compensation mechanism, leading to a reduction of all effort, and all output. Numerical analyses and implications for the use of multiple measures of performance-based incentives are provided.     

A theory of socialistic internal capital markets

We develop a model of a two-division firm in which the “strong” division has, on average, higher quality investment opportunities than the “weak” division. We show that, in the presence of agency and information problems, optimal effort incentives are less powerful and thus managerial effort is lower in the strong division. This leads the firm to bias its project selection policy against the strong division. The selection bias is more severe when there is a larger spread in the average quality of investment opportunities between the two divisions.     

Revenue Recognition in a Multiperiod Agency Setting

This paper examines how various revenue recognition rules affect the incentive properties of accounting information in a stewardship setting. Our analysis demonstrates that if revenues are recognized according to the realization principle, a single performance measure based on aggregated accounting information can be used to provide desirable production and effort incentives to the manager. In contrast, mark-to-market accounting does not provide efficient aggregation of raw information to solve the stewardship problem. Mark-to-market accounting, though sensible from a valuation perspective, fails to provide desirable incentives because it relies on the anticipated, rather than the actual, performance of the manager. We also consider a setting in which the manager can control the timing of the firm's sales. It then becomes desirable to modify the realization principle and apply the lower-of-cost-or-market valuation rule. The desirable accounting thus exhibits a conservative bias.     

The effects of monetary incentives on effort and task performance: theories, evidence, and a framework for research

The purpose of this paper is to review theories and evidence regarding the effects of (performance-contingent) monetary incentives on individual effort and task performance. We provide a framework for understanding these effects in numerous contexts of interest to accounting researchers and focus particularly on how salient features of accounting settings may affect the incentives-effort and effort-performance relations. Our compilation and integration of theories and evidence across a wide variety of disciplines reveals significant implications for accounting research and practice. Based on the framework, theories, and prior evidence, we develop and discuss numerous directions for future research in accounting that could provide important insights into the efficacy of monetary reward systems.     

Incentives and financial crises: Microfounded macroprudential regulation

We provide a micro-based rationale for macroprudential capital regulation of financial intermediaries (banks) by developing a model in which bankers can privately undertake a costly effort and reduce the probability of adverse shocks to their asset holdings that force liquidation (deterioration risk). A decline in the fundamental risk of assets ameliorates funding conditions, boosting the banks’ ability to expand their balance sheets. In principle, a higher continuation value would improve incentives to put effort. However, the rise in asset demand and prices also increases the payoff in liquidation, eventually reducing the equilibrium optimal effort. Poor incentives impose socially inefficient liquidation and can be corrected through a regulatory capital requirement. We show that the requirement should be high when fundamental risk is low. Therefore, the model suggests a theoretical foundation for macroprudential regulation and the countercyclical capital buffer of Basel III.     

Worker Incentives in the Banking Industry

Journal of Financial Services Research - This study shows that monetary incentives together with performance disclosures lead to significant increases in effort and productivity in the multi-branch...     

Relational contracting and endogenous formation of teamwork

We study a relational contracting model with two agents where each agent faces multiple tasks: effort toward the agent's own project and helping effort toward another agent's project. We show that the optimal task structure is either specialization without help or teamwork with a substantial amount of help: teamwork with a small amount of help is never optimal. Specialization with high‐powered incentives can be implemented by relative performance evaluation. However, under teamwork, the evaluation scheme must be substantially different to overcome the multitasking problem. Consequently, a small amount of help is dominated by specialization with high powered incentives.     

Incentives,wages, employment,and the division of labor in teams

We develop a theory of incentives, wages, and employment in the context of team production. A central insight is that specialization and division of labor not only improve productivity but also increase effort and the sensitivity of effort to incentives under moral hazard. We show that employment and incentives are complements for the principal when the positive effects of specialization and division of labor outweigh the increase in risk associated with additional employment and are substitutes otherwise. We provide new characterizations of the partnership, the firm, and the role of the budget‐breaker that are quite different from the classical literature.     

Perceived incentives to transdisciplinarity in a Japanese university research center

As a method of investigating complex socially relevant phenomena, transdisciplinary research (TDR) is gaining increasing centrality as a model of knowledge production. However, it is being discouraged by a scientific reward system based on disciplinary logic. The disincentive is even stronger for junior scholars who should be developing the capabilities necessary for achieving long-term scientific excellence.Building on theories of the coordination of scientific communities and using the case of a research center of Kyoto University investigating the boundary between cell and material sciences, we aim to disentangle the interplay between institutional incentives and intrinsic motivation in the prioritization of TDR over monodisciplinary research.We find that, despite strong interest in TDR among scientists and the center's mission to promote this orientation, only a minority of scientists prioritize this approach. Choice of research strategy is associated with its perceived benefits for idea generation, publication opportunities, intellectual effort required, the costs of team coordination, and satisfaction with organizational resources. Furthermore, the propensity to prioritize TDR drops among scientists beginning their careers.Therefore, we recommend the development of evaluation schemes grounded in activity-based measures and the granting of permanent positions to scientists pursuing TDR.