Informational asymmetry and incentives in firms: Theory and empirical evidence

This dissertation considers the design of compensation contracts when informational asymmetry is present in firms. The first essay focuses on the comparison between restricted stock and stock options for executive compensation, trading off incentives for effort against incentives for earnings management. The second essay examines the impact of disclosure regulation on investment efficiency. The third essay shows that the timing of reward reflects the timing of effort in a continuous-time model with three-sided moral hazard.; The first essay investigates the implications of stock-based compensation on earnings management, both theoretically and empirically. In particular, the essay addresses the following question: does restricted stock compensation induce more earnings management than stock option compensation? We show that increasing the moneyness of the options intensifies earnings management. Ceteris paribus, restricted stock thereby induces more earnings management than stock options. Our empirical evidence supports these predictions. The lag between the stock/option grants and the induced earnings management lies in the range of one to four years, which is consistent with the typical vesting schedules of restricted stock and stock options. Moreover, we examine theoretically the implications of regulatory changes on the optimal design of stock-based compensation. The results suggest that when accounting standards are improved, more stock options should be granted and with higher exercise prices.; Incentive contracts mitigate the investment inefficiency caused by asymmetric information but are often difficult to implement, particularly if the legal system does not permit enough pre-commitment. We analyze whether various disclosure regimes solve the incentive problem in a Myers-Majluf model with optimal contracting and renegotiation-proofness. We find that, while the disclosure of the manager's contract alone does not solve the problem, allowing earnings forecasts fixes incentives by eliminating the informational asymmetry about the new issue.; The third essay derives the optimal contract that provides incentives for employees to work together effectively on projects that develop over time. The optimal timing of compensation reflects the timing of effort with compensation for upfront effort preceding compensation for effort over time. The exact pattern of compensation depends on the relative severity of the agents' incentive problems.