Ernst Maug
Duke University, Durham, NC 27708
ABSTRACT
This paper reinvestigates the claim that managerial remuneration is not sufficiently dependent on changes in shareholder wealth. The model derives the optimal managerial contract as a function of ernings and the stock-price and shows that the optimal weight of stock price returns in managerial compensation contraacts balances the incentive role traditionally acknowledged by agency theory and the filtering role which reduces the coefficient of the stock price because the stock price filters macroeconomic shocks from earnings. The paper demonstrates how different stochastic environmentsdetermine the magnitude of these two effects and shows that agency theory does not restrict the coefficient on the stock price. The paper investigates the optimal performance contract if the macroeconomic shock is reflected in the stock market index. The model is extended to cases where the manager can manipulate accounting statements and where earnings do not reflect the value of current investments. The paper concludes that a low correlation between stock price returns and managerial compensation is consistent with agency theory.