COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1107

Information Externalities, Share-Price Based Incentives
and Managerial Behaviour

Simon Grant, Stephen King and Ben Polak

July 1995
Revised February 1997

We survey recent theoretical research on the effects of short-term share-price based marginal incentive schemes. Such schemes can induce inefficient managerial behaviour in both hidden action and hidden type contexts. These problems arise from informational asymmetries: managers take actions to manipulate the information flow rather than to maximize firm value. More generally, imperfect transmission of information between managers and shareholders or between managers of different firms can lead to similar distortions even when the parties' interests are aligned.