| Abstract: | This article develops an integrated model of asset pricing andmoral hazard. It is demonstrated that the expected dollar returnof a stock is independent of managerial incentives and idiosyncraticrisk, but the equilibrium price of the stock depends on them.Thus, the expected rate of return is affected by managerialincentives and idiosyncratic risk. It is shown, however, thatmanagerial incentives and idiosyncratic risk affect the expectedrate of return through their influence on systematic risk ratherthan serve as independent risk factors. It is also shown thatthe risk aversion of the principal in the model leads to lessemphasis on relative performance evaluation than in a modelwith a risk-neutral principal. |
