Pierre Chaigneau

The Informativeness Principle Under Limited Liability

This paper shows that the informativeness principle does not automatically extend to settings with limited liability. Even if a signal is informative about effort, it may have no value for contracting. An agent with limited liability is paid zero for certain output realizations. Thus, even if these output realizations are accompanied by an unfavorable signal, the payment cannot fall further and so the principal cannot make use of the signal. Similarly, a principal with limited liability may be unable to increase payments after a favorable signal. We derive necessary and sufficient conditions for signals to have positive value. Under bilateral limited liability and a monotone likelihood ratio, the value of information is non-monotonic in output, and the principal is willing to pay more for information at intermediate output levels.This paper studies the value of additional performance signals under limited liability. We show that -- contrary to the informativeness principle -- informative signals may have no value, because the payment cannot be adjusted to reflect the signal realization. We derive new conditions for a signal to have value under limited liability, and study how valuable signals should be incorporated into the contract. In a compensation setting, we show precisely how the signal realization should change the number of vesting options and the option strike price, providing guidance for performance-based vesting. Surprisingly, it may be optimal for more options to vest upon a negative signal of effort. In a financing setting, our results also have implications for whether the debt repayment should be performance sensitive.

The Optimal Timing of CEO Compensation

This paper extends a standard principal-agent model of CEO compensation by modeling the progressive attenuation of information asymmetries between firm insiders and shareholders in continuous time. In this setting, we show that the optimal timing of compensation results from a tradeoff between the progressive accumulation of noise in the stock price process and the progressive resolution of information asymmetries. Since all points in the stock price process are incrementally informative about the CEO action, we also show that the whole stock price process should a priori be used for compensation purposes. This may however lead CEOs to inefficiently divert resources to repeatedly manipulate the stock price, which is why it might be optimal to use only a few points in the stock price process instead.

Does Improved Information Improve Incentives

This paper studies the value of more precise signals on agent performance in an optimal contracting model with endogenous effort. With limited liability, the agent’s wage is increasing in output only if output exceeds a threshold, else it is zero regardless of output. If the threshold is sufficiently high, the agent only beats it, and is rewarded for increasing output through greater effort, if there is a high noise realization. Thus, a fall in output volatility reduces effort incentives—information and effort are substitutes—offsetting the standard effect that improved information lowers the cost of compensation. We derive conditions relating the incentive effect to the underlying parameters of the agency problem.

Risk aversion, prudence, and compensation

We use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by risk averse managers, in a fairly general setting. We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, prudence can contribute to explain the prevalence of stock-options in executive compensation. We also present a condition on the utility function which enables to compare the structure of optimal contracts associated with different risk preferences.In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function u who are risk averse ( u ′>0) and prudent ( u ′′>0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, managerial prudence can contribute to explain the prevalence of stock-options in executive compensation. However, convex contracts are not optimal when the principal is sufficiently prudent relative to the manager.

The Generalized Informativeness Principle

Holmström (1979) provides a condition for a signal to have positive value assuming the validity of the first-order approach. This paper extends Holmströms analysis to settings where the first-order approach may not hold. We provide a new condition for a signal to have positive value that takes non-local incentive constraints into account and holds generically. Our condition is the weakest condition possible in the absence of restrictions on the utility function.

Managerial Compensation and Firm Value in the Presence of Socially Responsible Investors

Shareholders with standard monetary preferences will give a manager incentives to increase firm profits, which can be achieved with equity grants. When shareholders are socially responsible, in the sense that they also value corporate social performance, it is not clear which incentives the manager should receive. Yet, in a standard principal–agent model, we show that the optimal contract is surprisingly simple: it consists in giving equity holdings to the manager. This is notably because the stock price will incorporate expected profits as well as the social performance of the firm, to the extent that it is valued by shareholders. Consequently, equity holdings give the manager incentives to jointly maximize the profits and the social performance of the firm according to shareholders’ preferences. To facilitate alignment of interests, more socially responsible firms will optimally hire more socially responsible managers. We conclude that neither the shareholder primacy model nor equity-based managerial compensation is necessarily inconsistent with the attainment of social objectives.

Downside Risk Neutral Probabilities

The price of any asset can be expressed with risk neutral probabilities, which are adjusted to incorporate risk preferences. This paper introduces the concepts of downside (respectively outer) risk neutral probabilities, which are adjusted to incorporate the preferences for downside (resp. outer) risk and higher degree risks. We derive new asset pricing formulas that rely on these probability measures. Downside risk neutral probabilities allow to value assets in a simple mean-variance framework. The associated pricing kernel is linear in wealth, as in the CAPM. With outer risk neutral probabilities, the pricing kernel is quadratic in wealth, and can be U-shaped.