On The Observational Equivalence Of Managerial Contracts Un

• Published in: The Quarterly journal of economics Vol. 103; no. 2; p. 425
• Main Authors: Hagerty, Kathleen M, Siegel, Daniel R
• Format: Journal Article
• Language: English
• Published: Oxford Oxford University Press 01-05-1988
• Subjects: Contracts; Economic models; Economic theory; Hazards; Managers; Moral; Moral hazard; Profit maximization; Selection; Self; Utility functions
• EISSN: 1531-4650
• ISSN: 0033-5533

Two models of contracting under asymmetric information (moral hazard and self selection) are used to explain the phenomenon of managerial contracts often tying compensation to the firm's performance. An important direction for research in this area will be to use data on managerial contracts to increase the understanding of the settings in which a given informational problem is most important. To determine whether this is possible using static models of contracting under asymmetric information, the standard principal-agent model developed by Grossman and Hart (1983) is compared with a plausible self-selection model, in which the firm only wants to hire a manager with a particular level of productivity. This self-selection model is called a talent search. It is shown that the mathematical statements of the moral hazard and talent search models are identical. The equivalence between the 2 models occurs because the individual rationality constraint is binding in the moral hazard problem.