Managerial compensation and the cost of moral hazard

This article investigates managerial compensation and its incentive effects . Our econometric framework is derived from a multiperiod principal-agent m odel with moral hazard. Longitudinal data on returns to firms and manageria l compensation are used to estimate the model. We find that firms would inc ur large losses from ignoring moral hazard, whereas managers only require m oderate additional compensation for accepting a contract that ties their we alth to the value of the firm. Thus the costs of aligning hidden managerial actions to shareholder goals through the compensation schedule are much le ss than the benefits from the resulting managerial performance.