NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
loading...

The Value of Informativeness for Contracting

Pierre Chaigneau, Alex Edmans, Daniel Gottlieb

NBER Working Paper No. 20542
Issued in October 2014
NBER Program(s):The Corporate Finance Program, The Law and Economics Program, The Labor Studies Program

The informativeness principle demonstrates qualitative benefits to increasing signal precision. However, it is difficult to quantify these benefits -- and compare them against the costs of precision -- since we typically cannot solve for the optimal contract and analyze how it changes with informativeness. We consider a standard agency model with risk-neutrality and limited liability, where the optimal contract is a call option. The direct effect of reducing signal volatility is a fall in the value of the option, benefiting the principal. The indirect effect is a change in the agent's effort incentives. If the original option is sufficiently out-of-the-money, the agent can only beat the strike price if he exerts effort and there is a high noise realization. Thus, a fall in volatility reduces effort incentives. As the agency problem weakens, the gains from precision fall towards zero, potentially justifying pay-for-luck.

download in pdf format
   (629 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w20542

Users who downloaded this paper also downloaded* these:
Durlauf, Navarro, and Rivers w21566 Model Uncertainty and the Effect of Shall-Issue Right-to-Carry Laws on Crime
Glaeser, Gottlieb, and Ziv w20291 Unhappy Cities
Chaigneau, Edmans, and Gottlieb w20456 The Informativeness Principle Under Limited Liability
Chaigneau, Edmans, and Gottlieb w20729 The Generalized Informativeness Principle
Lu, Mitchell, Utkus, and Young w21102 Borrowing from the Future: 401(k) Plan Loans and Loan Defaults
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us