Ambiguity sharing and the lack of relative performance evaluation

Wu, Yaoyao; Yang, Jinqiang; Zou, Zhentao

doi:10.1007/s00199-017-1056-x

Cited by 17 publications

(14 citation statements)

References 29 publications

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“…Suppose, following [1,9,24], that in addition to project performance, compensation contracts can be written on another variable that is correlated with the noise component of project performance. This variable is assumed to be uninformative about the EN's action.…”

Section: General Modelmentioning

confidence: 99%

“…Miao and Rivera [8] studied two types of robust contract problems with output uncertainty; they dealt the principal's maximization problem under the worst-case scenario and found ambiguity aversion lowers outside securities value while increases the credit yield spread. Wu et al [9] extended the Holmstrom and Milgrom [1] model by incorporating model uncertainty to study robust long-term contracting and explore the connection between ambiguity sharing and relative performance evaluation. In addition, they provided a theoretical explanation of paying for luck through writing the compensation contracts on additional signals, such as industry average performance.…”

Section: Introductionmentioning

confidence: 99%

“…Aggarwal and Samwick [12] assumed that the industry average performance might be affected by the agent's action and showed that strategic interactions among firms could explain the lack of relative performance-based incentives. Wu et al [9] found that the ambiguity reduces the use of relative performance evaluation and then increases the exposure of the common shocks in the agent's point of view. In contrast, we found that the cash flow evolves with the joint effect of the common shock and the idiosyncratic shock.…”

Section: Introductionmentioning

confidence: 99%

“…Another paper closely related to our study is that of Wu et al [9], who introduced probability measure ambiguity to analyze the continuous-time contract and focus on the research of relative performance evaluation. They found ambiguity induces a tradeoff between ambiguity sharing and incentives.…”

Section: Introductionmentioning

confidence: 99%

“…They found ambiguity induces a tradeoff between ambiguity sharing and incentives. However, many important models in finance and economics do not consider synergy between partners in the project [9,[21][22][23]. In contrast, we analyzed how complementarity of efforts affects the optimal pay-performance sensitivity level that the VC is willing to award to the EN.…”

Section: Introductionmentioning

confidence: 99%

See 4 more Smart Citations

Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect

Chang

Yang

2020

Mathematics

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In this paper, we established a continuous-time agency model in which an ambiguity-averse venture capitalist (VC) employs an ambiguity-neutral entrepreneur (EN) to manage an innovative project. We analyzed the connection between ambiguity sharing and incentives under double moral hazard. Applying a stochastic dynamic programming approach, we solved the VC’s maximization problem and obtained the Hamilton–Jacobi–Bellman (HJB) equation under a special form of the value function. We showed that the optimal pay-performance sensitivity was a fixed point of a nonlinear equation. The model ambiguity on the probability measure induced a tradeoff between ambiguity sharing and the incentive compensation that improved the EN’s pay-performance sensitivity level. Besides, we simulated the model and showed that when two efforts were complementary, the VC’s effort did not monotonically decrease with respect to the pay-performance sensitivity, while the EN’s effort did not monotonically increase in the pay-performance sensitivity level. More importantly, we found that as efforts tended to be more complementary, the optimal pay-performance sensitivity tended to approach those that maximized the efforts exerted by the EN and the VC.

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Section: General Modelmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect

Chang

Yang

2020

Mathematics

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Contracting Under Ambiguity in Continuous Time

Sung

2023

Contract Theory: Discrete- And Continuous-Time Models

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Incentive contracting under ambiguity aversion

2017

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This paper studies a principal-agent model in which the information on future firm performance is ambiguous and the agent is averse to ambiguity. We show that if firm risk is ambiguous, while stocks always induce the agent to perceive a high risk, options can induce him to perceive a low risk. As a result, options can be less costly in incentivizing the agent than stocks in the presence of ambiguity. In addition, we show that providing the agent with more incentives would induce the agent to perceive a higher risk, and there is a discontinuous jump in the compensation cost as incentives increase, which makes the principal reluctant to reset contracts frequently when underlying fundamentals change. Thus, compensation contracts exhibit an inertia property. Lastly, the model sheds some light on the use of relative performance evaluation, and provides a rationale for the puzzle of pay-for-luck in the presence of ambiguity.

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Ambiguity sharing and the lack of relative performance evaluation

Cited by 17 publications

References 29 publications

Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect

Venture Capital Contracting with Ambiguity Sharing and Effort Complementarity Effect

Contracting Under Ambiguity in Continuous Time

Incentive contracting under ambiguity aversion

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