We present a moral-hazard-based hierarchical contracting model, where investors con-
tract the top manager and the top manager contracts all middle managers. We compare
e®ects of hierarchical contracting on managerial contract sensitivities with those of a di-
rect contracting benchmark where investors directly contract all managers. We argue that
under hierarchical contracting, the top manager shifts his compensation risk to middle man-
agers by providing middle managers with higher-powered incentive contracts than would
be desired by investors under direct contracting. It is striking that this top managerial risk-
shifting behavior motivates investors to design the top managerial contract in such a way
that the top-managerial hierarchical contract sensitivity approaches either the ¯rst best or
zero, as the ¯rm size grows. However, under some reasonable conditions such as correlated
managerial e®ort outcomes, the top managerial sensitivity quickly approaches zero as the
¯rm size increases, and consequently, the sensitivity for large ¯rms can be far lower than
predicted by the standard agency theory. This result can serve as an explanation of widely
observed ¯rm-size e®ects on CEO compensations, namely, lower pay sensitivities for large
¯rms than those for small ¯rms. We also argue that even when investors are risk-neutral
and then individual performance outcomes of nonexecutive employees may be very weakly
correlated to the total outcome of the ¯rm, company-wide bonus plans for nonexecutive
employees can still be justi¯ed under hierarchical contracting.
Keywords: hierarchical contract, ¯rm size, pay sensitivity, CEO compensation, middle
managerial contract, principal-agent problem, many agents, moral hazard, team, perfor-
mance measure, continuous-time model
학술 대회
학술대회 목차
[2007년 제 3차] Hierarchical Contract, Firm Size, and Pay Sensitivi
작성자 : 관리자
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게시일 :
2007-08-24
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