Prof. Mihail Zervos (London School of Economics)
We consider managerial incentive provision under moral hazard in a firm that is subject to stochastic growth opportunities. In the model that we study, managers are dismissed after poor performance as well as when an opportunity to improve the firm's profitability that requires a change of management arises. The optimal contract may induce managerial entrenchment, whereby, ex post-attractive growth opportunities are foregone after good performance because of contractual commitments. Realised growth depends on the frequency and size of growth opportunities as well as on the severity of moral hazard. The prospect of growth-induced turnover limits the firm's ability to rely on deferred compensation as a disciplinary device.