ACCOUNTING INCOME, STOCK-PRICE, AND MANAGERIAL COMPENSATION

This paper employs an agency model where a manager has a two-dimensional action choice to study how the information content of earnings affects the design of compensation contracts based on earnings and price. Price is modeled as an endogenous variable that reflects all available information, including earnings. Two settings are contrasted. In the first, earnings and price reflect the same underlying information about firm value, while in the second, earnings reflect a subset of the information reflected in price. It is shown that differences in information content substantially alter the characteristics of compensation contracts based on earnings and price.