Tournament Rewards and Risk Taking

I consider two seemingly unrelated puzzles; 1.Why is relative performance evaluation (RPE) used less in CEO compensation than agency theory suggests? 2.Why is sometimes, e.g., for fund managers, a mediocre performance more highly rewarded than excellence? I consider a simple tournament model, where agents can influence the spread of output in addition to its mean. I show that standard tournament rewards induce risky and lazy behavior from the agents. This finding sheds light on Puzzle 1. Second, I consider a scheme that ranks agents according to their relative closeness to a benchmar k. I show that there exists intermediate values of k such that the risky-lazy problem of the standard tournament can be mitigated. This result sheds light on Puzzle 2.

Stock Investments at Work

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A Theory of Capital Structure with Strategic Defaults and Priority Violations

We reformulate the classic CSV model of financial contracting from Townsend (1979) and Gale & Hellwig (1985) to tackle criticisms raised against it voiced by Hart (1995), such as lack of optimal behavior at the repayment stage and an inability to allow for outside equity. As a result, we obtain a theory of capital structure that accommodates empirical regularities such as bankruptcies, strategic defaults of debt obligations, and violations of absolute priority rules as parts of the equilibrium description.Cash Diversion, Costly State Verification, Outside Equity, Financial Contracts.

Worker Discretion and Misallocation of Talent within Firms

We develop a theory of worker discretion over task choice within a firm. Increasing the workers’ discretion has a trade-off between the gains from workers using private information about their abilities, and the costs from adverse selection within the firm due to workers herding into prestigious tasks. The theory leads to the result that, in line with the Peter Principle, misallocation of talent within firms takes the form of too many workers undertaking tasks with a high return to ability. Moreover we find that the degree of misallocation of talent is decreasing in the degree of discretion given to workers.Authority, Bureaucracies, Career Concerns, Discretion, Organizational Design, Misallocation, Peter Principle, Principal-Agent Theory, Sun Hydraulics, Wage Dynamics

A Theory of Capital Structure with Strategic Defaults and Priority Violations

Why do firms delegate job design decisions to workers and what are the implications of such delegation? We develop a private-information based theory of delegation where delegation provides a more efficient allocation of talent inside the firm, but at the cost that low ability workers must be compensated to self-sort. Career concerns limit the effectiveness of delegation: when returns to ability or market observability of job content are high, the compensation needed to get low-ability workers to self-sort is high, and firms limit delegation to avoid cream-skimming of the high-ability workers. We investigate implications for how misallocation of talent within firms may occur, the optimal design of incentive contracts, and which decisions are more likely to be delegated to subordinates.Cash Diversion, Costly State Verification, Outside Equity, Financial Contracts.

Management of Knowledge Workers

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Does Source of Income Affect Risk and Intertemporal Choices?

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Do Entrepreneurs Matter?

Publisher PD

University Innovation and the Professor’s Privilige

Publisher PD

Do entrepreneurs matter?

In the large literature on firm performance, economists have given little attention to entrepreneurs. We use the deaths of 500 entrepreneurs as a source of exogenous variation, and ask whether this variation can explain shifts in firm performance. Using longitudinal data, we find large and sustained effects of entrepreneurs at all levels of the performance distribution. Entrepreneurs strongly affect firm growth patterns of very young firms and for firms that have begun to mature. We do not find significant differences between small and larger firms, family and non-family firms, nor between firms located in urban and rural areas, but we do find stronger effects for founders with high human capital. Overall, the results suggest that an often overlooked factor - individual entrepreneurs - plays a large role in affecting firm performance