Essays on the economic theory of managerial incentives

Corporations are very common in the business world. In this kind of organizations shareholders are protected by limited liability and, furthermore, they can easily transfer their shares. As a consequence, investors might be interested in buying a corporation's shares just to diversify their portfolios, without any real interest in getting involved in management. It is therefore much easier for corporations to obtain external finance than other organizational forms, and this might well be the basic reason for their wide diffusion. For the very same reason, however, it is necessary to hire professional managers to make all the relevant decisions, and this contains the seed of their problematic governance. In fact, the separation of ownership and control produces a conflict of interest between shareholders, interested in maximizing the firm value, and managers, who can be interested in pursuing a variety of different objectives (empire building, entrenchment, shirking, etc.). This dissertation is composed by three research papers dealing with the economics of managerial incentive provision. It is common to interpret the relationship between shareholders and managers as an agency relationship affected by both a moral hazard and adverse selection problem. Usually, managerial incentives are affected by several elements such as, for example, their compensation packages and career concerns, the internal monitoring of the board of directors, the external monitoring of the market for corporate control, etc. This dissertation suggests that it might be necessary to consider Overview 2 the interactions between alternative incentive mechanisms both to better understand their functioning and, at least as importantly, to help interpreting empirical observations. The first chapter, Paying for Observable Luck, proposes a simple hidden action model which explains recent empirical evidence of asymmetric benchmarking in managerial compensation: managers appear to be insulated from bad luck but not from good luck. The explanation hinges on the interaction between explicit contractual incentives and implicit incentives deriving from the possibility of bankruptcy. The second chapter, Career Concerns and Competitive Pressure, studies how the level of competition in the product market a ects the strength of managerial career concerns. Good managers are in short supply so that firms are willing to compete for them. However, the value of good managers depends on the profit differential they are able to produce on the product market. It is then shown that increased competition makes career concerns stronger if it increases such profit differential. The third chapter, Managerial Entrenchment and the Market for CEOs, suggests that the observed trends of increased managerial pay and increased board independence might be related. Boards captured by an entrenched managers are not active on the demand side of the managerial labor market. Therefore, increased board independence, reducing the number of captured boards, also increases competition for good managers, then rising their pay and making their career concerns stronger

To Preference via Entrenchment

We introduce a simple generalization of Gardenfors and Makinson's epistemic entrenchment called partial entrenchment. We show that preferential inference can be generated as the sceptical counterpart of an inference mechanism defined directly on partial entrenchment.Comment: 16 page

The lexicographic closure as a revision process

The connections between nonmonotonic reasoning and belief revision are well-known. A central problem in the area of nonmonotonic reasoning is the problem of default entailment, i.e., when should an item of default information representing "if A is true then, normally, B is true" be said to follow from a given set of items of such information. Many answers to this question have been proposed but, surprisingly, virtually none have attempted any explicit connection to belief revision. The aim of this paper is to give an example of how such a connection can be made by showing how the lexicographic closure of a set of defaults may be conceptualised as a process of iterated revision by sets of sentences. Specifically we use the revision process of Nayak.Comment: 7 pages, Nonmonotonic Reasoning Workshop 2000 (special session on belief change), at KR200