Negotiated Transfer Pricing and Divisional vs. Firm-Wide Performance Evaluation

1999 ◽  
Vol 74 (1) ◽  
pp. 87-104 ◽  
Author(s):  
Regina M. Anctil ◽  
Sunil Dutta
Keyword(s):  
Risk Sharing ◽  
Transfer Pricing ◽  
Linear Functions ◽  
Managerial Compensation ◽  
Risk Averse ◽  
Compensation Contracts ◽  
Optimal Contracts ◽  
Total Surplus ◽  
Specific Investments ◽  
Optimal Linear

A firm with two divisions, each run by a risk-averse manager, contracts with the two managers to operate their divisions and possibly engage in interdivisional trade. Each division can increase the total surplus generated through interdivisional trade by making costly relationship-specific investments. The terms of trade are determined through negotiations between the two managers. Managerial compensation contracts are linear functions of divisional profit and firm-wide profit. If managers are compensated solely on the basis of their divisional profits, they invest less than the first-best amounts. While compensation contracts based on firm-wide profits alone can induce first-best investments, they impose extra risk on risk-averse managers. Therefore, we find that optimal linear compensation contracts will contain both divisional and firm-wide components. Our analysis also identifies a feature of negotiated transfer pricing, namely interdivisional risk sharing, and characterizes its impact on the design of optimal contracts.

Fair and Square: A Retention Model of Managerial Compensation

2021 ◽  
Author(s):  
Tore Ellingsen ◽  
Eirik Gaard Kristiansen
Keyword(s):  
Behavioral Economics ◽  
Stock Option ◽  
Managerial Compensation ◽  
Risk Averse ◽  
Perceived Fairness ◽  
Retention Model ◽  
Compensation Contracts ◽  
Severance Pay ◽  
Variable Pay ◽  
Empirical Regularities

We propose a model of how the retention motive shapes managerial compensation contracts. Once employed, a risk-averse manager acquires imperfectly portable skills whose value is stochastic because of industry-wide demand shocks. The manager’s actions are uncontractible, and the perceived fairness of the compensation contract affects the manager’s motivation. If the volatility of profits is sufficiently large and outside offers are sufficiently likely, the equilibrium contract combines a salary with an own-firm stock option. The model’s predictions are consistent with empirical regularities concerning contractual shape, the magnitude of variable pay, the lack of indexation, and the prevalence of discretionary severance pay. This paper was accepted by Axel Ockenfels, behavioral economics and decision analysis.

scholarly journals World Income Components: Measuring and Exploiting Risk-Sharing Opportunities

2001 ◽  
Vol 91 (4) ◽  
pp. 1031-1054 ◽  
Author(s):  
Stefano G Athanasoulis ◽  
Robert J Shiller
Keyword(s):  
Risk Premium ◽  
Risk Sharing ◽  
Absolute Risk ◽  
Optimal Contract ◽  
Optimal Contracts ◽  
Variance Matrix ◽  
The World ◽  
Penn World Table ◽  
World Income ◽  
Table Data

A method is constructed for decomposing the variance of changes in incomes in the world into components, to indicate the most important risk-sharing opportunities among people of the world. A constant absolute risk premium (CARP) model, an intertemporal general-equilibrium model of the world, is presented to permit optimal contract design. For a contract designer maximizing a social welfare function, the optimal contracts maximize the equilibrium world real interest rate. Securities are defined in terms of eigenvectors of a transformed variance matrix. The method is applied using Penn World Table data on the G-7 countries, 1950–1992. (JEL F00, G00, G10)

scholarly journals Optimal contracts with a risk‐taking agent

2020 ◽  
Vol 15 (2) ◽  
pp. 715-761 ◽  
Author(s):  
Daniel Barron ◽  
George Georgiadis ◽  
Jeroen Swinkels
Keyword(s):  
Risk Taking ◽  
Limited Liability ◽  
Risk Averse ◽  
Trade Off ◽  
Optimal Contracts ◽  
Risk Neutral ◽  
Profit Maximizing ◽  
Over Time

Consider an agent who can costlessly add mean‐preserving noise to his output. To deter such risk‐taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk‐neutral and protected by limited liability, this concavity constraint binds and so linear contracts maximize profit. If the agent is risk averse, the concavity constraint might bind for some outputs but not others. We characterize the unique profit‐maximizing contract and show how deterring risk‐taking affects the insurance‐incentive trade‐off. Our logic extends to costly risk‐taking and to dynamic settings where the agent can shift output over time.

Creation and Regulation of Bank Liquidity

2019 ◽  
pp. 180-226 ◽  
Author(s):  
Christa H. S. Bouwman
Keyword(s):  
Risk Sharing ◽  
Capital Requirements ◽  
Empirical Literature ◽  
Shadow Banking ◽  
Basel Iii ◽  
Risk Averse ◽  
Funding Liquidity ◽  
Open Research ◽  
Core Function ◽  
Research Questions

Liquidity creation is a core function of banks and an important economic service to the economy. This chapter discusses two distinct notions of bank liquidity creation developed in the theoretical literature—funding liquidity creation and improved risk sharing for risk-averse depositors. It also examines the empirical literature on bank liquidity creation. The focus is on the economics of bank liquidity creation, both in the traditional relationship banking context and in the shadow-banking context. This chapter discusses related prudential regulation issues, pertaining mainly to capital requirements and liquidity requirements, as well. It provides a historical overview, starting in the early 1800s and ending with Basel III and the Dodd–Frank Act. It identifies open research questions regarding both capital requirements and liquidity requirements.

Motivating high‐impact innovation: Evidence from managerial compensation contracts

2019 ◽  
Vol 28 (3) ◽  
pp. 291-318 ◽  
Author(s):  
Bill B. Francis ◽  
Iftekhar Hasan ◽  
Zenu Sharma ◽  
Maya Waisman
Keyword(s):  
High Impact ◽  
Managerial Compensation ◽  
Compensation Contracts

REPUTATION AND OPTIMAL CONTRACTS FOR CENTRAL BANKERS

2011 ◽  
Vol 15 (4) ◽  
pp. 441-464 ◽  
Author(s):  
Kevin X. D. Huang ◽  
Guoqiang Tian
Keyword(s):  
Central Bank ◽  
Concave Function ◽  
Time Inconsistency ◽  
Economic Outcomes ◽  
Linear Functions ◽  
Global Maximum ◽  
Equilibrium Path ◽  
Optimal Contracts ◽  
Hybrid Mechanism ◽  
Inflation Rates

We implement optimal economic outcomes at the lowest social cost by combining reputation and contracting mechanisms to overcome the time-inconsistency problem of monetary policy associated with an inflation bias. We characterize the conditions under which the reputation force alone induces a central bank to behave in a socially optimal way. When these conditions fail, an incentive contract is invoked, whose cost is significantly reduced by the presence of the reputation force. The contract poses a penalty threat that is a concave function of wage growth, which in equilibrium is tied to expected rather than realized inflation, with a global maximum that provides the least upper bound on all threatened penalties. This bound can be used as a uniform penalty threat to achieve optimal economic outcomes and still, for moderate to large shocks, its magnitude can be much smaller than the size of the transfers required by the standard contracts that are linear functions of realized inflation rates. Further, under both the concave and the uniform penalty threats, the central bank will behave in the socially optimal way and no transfer is materialized in equilibrium. Thus our hybrid mechanism solves the time-inconsistency problem while leaving the central bank with complete discretion to respond to new circumstances, without any reputation cost or penalty threatened by the contract actually invoked along the equilibrium path.

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