This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.

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This paper summarizes the empirical and theoretical research on executive compensation and provides a comprehensive and up-to-date description of pay practices (and trends in pay practices) for chief executive officers (CEOs). Topics discussed include the level and structure of CEO pay (including detailed analyses of annual bonus plans, executive stock options, and option valuation), international pay differences, the pay-setting process, the relation between CEO pay and firm performance (“pay-performance sensitivities”), the relation between sensitivities and subsequent firm performance, relative performance evaluation, executive turnover, and the politics of CEO pay.

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Personnel economics has grown over the past twenty years to become a major branch of labor economics. Beginning primarily as a theoretical field, recent empirical analyses have provided support for earlier theories. Personnel economics is distinguished from traditional personnel analysis in that it is economics. As such, personnel economists assume maximizing agents, invoke the concept of equilibrium, and focus on economic efficiency. Although much has been learned, many important questions remain. For example, are worker wage profiles dependent on individual attributes or is the firm more important in determining wage growth? Why are executives so highly paid and why does the pay take the form that it does? Why has the use of stock and stock options grown and why is stock sometimes given even to lower level employees? How can cross-country differences in pay patterns be explained? Does variable pay provide better incentives than do fixed hourly wages? Under which circumstances is one form of compensation used over another? These questions and others are investigated and some conjectures are offered. Personnel economics is defined as the application of microeconomic principles to human resources issues that are of concern to most businesses. The field, now about twenty years old, arose for three reasons. First, those of us who were teaching standard labor

We explore behavioral explanations for sub-optimal corporate investment decisions. Focusing on the sensitivity of investment to cash flow, we argue that personal characteristics of chief executive officers, in particular overconfidence, can account for this widespread and persistent investment distortion. Overconfident CEOs overestimate the quality of their investment projects and view external finance as unduly costly. As a result, they invest more when they have internal funds at their disposal. We test the overconfidence hypothesis, using data on personal portfolio and corporate investment decisions of CEOs in Forbes 500 companies. We classify CEOs as overconfident if they repeatedly fail to exercise options that are highly in the money, or if they habitually acquire stock of their own company. The main result is that investment is significantly more responsive to cash flow if the CEO displays overconfidence. In addition, we identify personal characteristics other than overconfidence (education, employment background, cohort, military service, and status in the company) that strongly affect the correlation between investment and cash flow. We are indebted to Brian Hall and David Yermack for providing us with the data. We are very grateful to Jeremy Stein for his invaluable support and comments. We also would like to thank Philippe Aghion, George

: Traditional theories of intermediation are based on transaction costs and asymmetric information. They are designed to account for institutions which take deposits or issue insurance policies and channel funds to firms. However, in recent decades there have been significant changes. Although transaction costs and asymmetric information have declined, intermediation has increased. New markets for financial futures and options are mainly markets for intermediaries rather than individuals or firms. These changes are difficult to reconcile with the traditional theories. We discuss the role of intermediation in this new context stressing risk trading and participation costs. Keywords : intermediation, risk management delegated monitoring, banks, participation costs JEL Classification : 310, 020, 610 1. Introduction In this paper we review the state of intermediation theory and attempt to reconcile it with the observed behavior of institutions in modern capital markets. We argue...

Does CEO overconfidence help to explain merger decisions? Overconfident CEOs overestimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal overinvestment in their company and their press portrayal. We find that the odds of making an acquisition are 65 % higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (–90 basis points) is significantly more negative than for non-overconfident CEOs (–12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

The language of game theory—coalitions, payo¤s, markets, votes— suggests that it is not a branch of abstract mathematics; that it is motivated by and related to the world around us; and that it should be able to

1I would like to thank Canice Prendergast for suggesting this problem and for helpful comments on a first draft. I also greatly appreciated the comments of Janet Currie and Jonathan Levin, and thank Mehdi Farsi for excellent This paper extends the standard principal-agent model to allow for subjective evaluation. It is shown that the optimal contract entails the use of more compressed evaluations relative to the case with verifiable performance measures. The optimal degree of compression trades off incentives against the costly conflict that arises when the principal and agent do agree regarding what constitutes appropriate performance. When applied to the problem of discrimination, it is shown that more able individuals in a discriminated against group may receive lower wages if they are less tolerant of discrimination. Finally, the optimal contract entails the use bonuses pay rather than the threat of dismissal, and hence efficiency wages are not in general Like the parents in Garrison Keillor’s Lake Woebegone, where all the children are above average, supervisors also have a tendency to judge their workers as above average, resulting in performance evaluations that are morecompressedandlessvariablethanactualperformance.Inthispaperitisshownthatsuchcompression is a feature of the optimal contract between a risk neutral principal and a risk averse agent when rewards are