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Garrett, Daniel
Pavan, Alessandro
Year of Publication: 
Series/Report no.: 
Discussion Paper No. 1579
Northwestern University, Kellogg School of Management, Center for Mathematical Studies in Economics and Management Science, Evanston, IL
We study the optimal dynamics of incentives for a manager whose ability to generate cash .ows changes stochastically with time and is his private information. We show that, in general, the power of incentives (or "pay for performance") may either increase or decrease with tenure. However, risk aversion and high persistence of ability call for a reduction in the power of incentives later in the relationship. Our results follow from a new variational approach that permits us to tackle directly the "full program," thus bypassing some of the difficulties of working with the "relaxed program" encountered in the dynamic mechanism design literature.
managerial compensation
power of incentives
pay for performance
dynamic mechanism design
adverse selection
moral hazard
persistent productivity shocks
risk aversion
Document Type: 
Working Paper

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