ISSN:
1617-7134
Source:
Springer Online Journal Archives 1860-2000
Topics:
Economics
Notes:
Abstract The issue of whether agency problems can be resolved by using standard derivative contracts continues to interest students of incentive structures of organizations. In this paper, we identify under limited liability a necessary and sufficient condition for standard share-derivative contracts to resolve moral hazard problems. This condition is remarkably simple: in addition to having large enough expected profit, the insiders of the firm must be able to hold combinations of call and put options in excess of the available underlying assets. Feasibility of delivery makes this condition not credible in the capital markets. Therefore, to circumvent this constraint one must have resort to private arrangements. This explains why incentive contracts often involve elements such as bonuses, penalties, and promotions, that are not able to be mimicked by standard derivative contracts.
Type of Medium:
Electronic Resource
URL:
http://dx.doi.org/10.1007/BF01238967
Permalink
