Tying executive pay to corporate performance has become increasingly important in creating incentives for corporate managers. Theoretical models argue that compensation contracts that reward managers contingent on performance, especially performance relative to peer firms, can increase managerial effort (e.g., Holmstrom, 1979, 1982). The effectiveness of performance-based pay in motivating managers, however, could be limited, especially if self-interested managers can negate its incentive effect. In a new paper, I investigate one such action, insider trading.
Theoretical models suggest that insider trading may be a suboptimal way to compensate management. For instance, Fischer (1992) argues that allowing insider trading can exacerbate existing … Read more