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Managerial compensation and research and development investment in a two-period agency setting

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Abstract

To investigate the relationship between managerial compensation and research and development (R&D) investment under asymmetric information, this paper establishes a two-period principal-agency model, in which the firm owner hires a risk-averse manager to operate the firm and to make the R&D investment decision. The manager has private information regarding the profitability of the R&D investment. Firstly, we present an R&D investment problem under symmetric information as the benchmark. Then, we discuss the scenario with asymmetric information about the profitability, and the firm owner offers new optimal incentive contact. We compare the differences of the company’s R&D investment decisions and choices of the compensation contract under symmetric and asymmetric information cases by numerical experiments. We find that the manager receives an upward distortion in the first-period bonus share rate, and a downward distortion in the second-period bonus share rate. Meanwhile, the R&D investment is less than the symmetric information case. At last, the variable outside option has no effect on the optimal manager’s compensation contract when the marginal cost of R&D investment is relatively small or under symmetric information case.

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Notes

  1. Many common distributions satisfy this assumption, such as uniform, normal, exponential, and power function distributions (Bagnoli and Bergstrom 2005).

  2. There are other kinds of contracts in the literature, such as log-linear contract (Edmans and Gabaix 2011) and general nonlinear contract (Hölmstrom 1979; Oyer 1998; Edmans and Gabaix 2016). But linear incentive contracts are still commonly used in the literature. Lambert (2001) summarized three common justifications for the linear contracting restriction: (1) optimal in a richer (but typically unmodeled) setting; (2) commonly used in practice; and (3) simply their tractability.

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Acknowledgements

This work was supported by Natural Science Foundation of Hebei Province of China (F2015201142) and Humanities Social Sciences Research Project of Colleges and Universities in Hebei Province (SD171005).

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Authors and Affiliations

  1. School of Management, Hebei University, Baoding, 071002, China

    Zhiying Zhao, Guoqing Yang & Jianmin Xu

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  1. Zhiying Zhao
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  2. Guoqing Yang
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  3. Jianmin Xu
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Correspondence to Guoqing Yang.

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This article does not contain any studies with human participants or animals performed by any of the authors.

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Communicated by X. Li.

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Zhao, Z., Yang, G. & Xu, J. Managerial compensation and research and development investment in a two-period agency setting. Soft Comput 22, 5453–5465 (2018). https://doi.org/10.1007/s00500-018-3132-y

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