Corporate Finance, Contract Theory, Information Economics, Financial Markets
Firm Performance Pay as Insurance (Job Market Paper)
The prevalence of risky firm performance pay for non-executive employees presents a puzzling departure from conventional contract theory, which predicts insurance provision by the firm. I analyze a principal-agent model that accounts explicitly for the implicit incentives from internal promotions. A worker's likelihood of being promoted is low when many workers do well. At the same time, firm performance is high because it is an aggregation of individual performances. The optimal contract for a lower-level employee features firm performance pay because it provides a hedge against not being promoted. Thus, firm performance pay is not indicative of inefficient risk-sharing; rather, it is the insurance. The model’s predictions are consistent with observed phenomena such as option-like payoffs, performance-based vesting, and over-valuation of equity pay.
Firm payout policies increasingly involve open-market stock buybacks. The prevalence of such programs is puzzling because trading by an informed manager may increase liquidity trading costs. This paper analyzes a Kyle micro-structure setting in which the firm competes against other informed traders. Informed buybacks intensify the competition for trading profits, making the order flow more informative. However, repurchases generate trading gains that make the firm’s actual value per-share higher, but only when its stock is undervalued. This effect makes private information about the firm’s fundamentals even more valuable. This paper provides conditions under which the first effect dominates the second and repurchase programs mitigate the adverse selection problem, rather than exacerbate it. These conditions help explain the substantial size and pro-cyclicality of buyback programs.
Works in Progress
Public and Private Weather Information in the Orange Juice Market (with Thomas Gilbert)
We exploit the commission / decommission of weather stations in Florida's orange producing counties as an exogenous change to the public information set to analyze the incremental information content of financial markets.