Insider Information and Performance Pay

This paper provides evidence that managers have private information they exploit for …nancial gain at the expense of shareholders. It develops a model of optimal contracting to show that moral hazard, hidden actions taken by agents, can rationalize why a principal would optimally induce agents to bene…t from their private information. Estimates from a structural model shows that moral hazard is an important economic factor. This leads to the conclusion that, in practice, shareholders and managers might optimally agree upon an arrangement where managers systematically exploit their private information about the …rm.