Comments on Discretion and the Complexity of Simple Incentive Contracts by Felix Hoppe and Frank Moe

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Comments onDiscretion and the Complexity of
Simple Incentive Contractsby Felix Hoppe and
Frank Moers

• Shijun Cheng
• University of Michigan

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Discretion in compensation

• A simple modelC ß0 ß1X1 ß2X2 ?1Z1
  ?2Z2, where Xs are contractible, Zs are
  non-contractible (and unobservable to others).
• Discretion- General measuring Xs, Zs, setting
  ßs, ?s everywhere.- The paper, roughly for
  annual bonus, (1) setting ß1X 1, when ß20, and
  (2) setting ßs, when both ßs are non-zero.-
  Some questions (1) measuring Xs, Zs, (2) when
  ?1 ?20? (3) discretion in ß1 vs. X1? (4) how to
  distinguish between ?1?0 and ?2?0, and
  discretionarily setting ßs? (5) reduction in risk
  (X1) vs. reduction in noncongruence (ßs)? (6) for
  equity-based compensation? (7) retention
  decisions?

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Several empirical issues

• The authors subsamples-earnings (with
  discretion vs. without) (26 vs. 74)-multiple
  (with discretion vs. without) (80 vs. 20)-
  self-selection into the subsamples.
• Why not all firms (especially given the authors
  classification of discretion is somewhat unclear)
  ?- earnings subsample 46 multiple subsample
  54- four categories together earnings with
  discretion 46 26 12 earnings without
  discretion 46 74 34 multiple with
  discretion 54 80 43 multiple without
  discretion 54 20 11- Also, as the first
  tests with vs. without discretion (55 vs.
  45) earnings vs. multiple (46 vs. 54) ---
  better studied in the literature.

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Several empirical issues

• Measurement of variables- Discretion ex ante
  vs. ex post? Actual vs. reported (in the proxys)?
  firm or firm-year classifications?- Noise in
  performance measure variability of industry
  median accounting return- Environmental
  uncertainty the firms stock return
  volatility.- Need theory guidance here.-
  Director knowledge board size, of busy
  outsiders, of busy insiders- How about
  expertise as in audit committee studies?
• Analyses- Main effects of noise and
  uncertainty ? - Interaction effects in probit
  models- A suggestion Industry vs.
  firm-specific noise/uncertainty in determining
  discretion?

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Summary

• Interesting paper
• Some suggestions- Reconsider the research
  questions- Clarify discretion, noise, and
  uncertainty- Modify the empirical design