EARNINGS-BASED COMPENSATION CONTRACTS UNDER ASYMMETRIC INFORMATION

We analyse a model with two-dimensional asymmetric information in which the employer has better information about the firm's earnings potential. The employee's contract consists of an annual bonus and stock options. We explain (1) how different degrees of asymmetric information about short-term earnings versus long-term earnings affect optimal contracts and (2) why firms offering more options have higher short-term performance and lower long-term performance. This provides new insights into the structure of earnings-based compensation. Copyright © 2009 The Author. Journal compilation © 2009 Blackwell Publishing Ltd and The University of Manchester.