"Acquisition of Information to Diversify Contractual Risk"
International Economic Review,
Volume: 53 | Issue: 1 | Pages: 133-156
Publication type: Journal article
This paper analyzes a principal-agent problem where the agent can search for and trade financial assets to diversify his compensation risk. Prior to the portfolio decision, the agent acquires information on how the financial assets available in the market fit his diversification purposes. We model this information acquisition activity as a costly search process. The amount of risk that the agent diversifies is decreasing in information acquisition cost and increasing in the asset market's sophistication, measured by the variety of financial assets available. As the agent gains access to an asset market with lower information acquisition costs and higher sophistication, the optimal compensation contract involves more performance sensitive pay and elicits a higher level of effort.
The PDF above is the pre-peer reviewed version of the article: published in final form at the International Economic Review.
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