Discussion Paper, Center for Mathematical Studies in Economics and Management Science 1579
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