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Posted by: Michael Mandel on August 03
A new academic paper makes a credible argument that stock option contracts for executives can cause excessively large swings in the economy. The paper, which I think is destined to become a classic, has a great title: “Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts. ”
John Donaldson, Natalia Gershun and Marc Giannoni( of the Columbia Business School, Pace University, and Columbia Business School) examine stock options, and point out that:
With such a compensation contract, a given increase in the firm’s output generated by an additional unit of physical investment results in a more than proportional increase in the manager’s income. We find that incentive contracts of this form can easily result in an indeterminate general equilibrium, with business cycles driven by self-fulfilling fluctuations in the manager’s expectations. These expectations are unrelated to fundamentals. Arbitrarily large fluctuations in macroeconomic variables may possibly result.
This is not a good thing. What it means is that managerial confidence, rather than consumer confidence, has now become a central driving force for economic fluctuations.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.