Pay package reshuffling and managerial incentives: A principal-agent analysis
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By deferring a significant portion of managers' remuneration, managers bear the risk of their choices for a longer period of time and avoid excessive risk taking. The effectiveness of this mechanism is jeopardized if managers reshuffle their pay packages; this is possible when trades in the components of pay packages are not verifiable. In this paper, we investigate the relevance of trade verifiability in pay packages design. We analyze a principal-agent model with agent's compensation made of different commodities which can be exchanged on competitive markets at given prices. We consider both the case when trades in commodities are verifiable, and when they are not. We prove that an optimal contract when trades are verifiable remains optimal when trades are not verifiable if agent's preferences for commodities are independent of the action performed. We provide examples to illustrate what happens when preferences' independence fails.