DP12355 Profit Sharing and Incentives

Author(s): Emre Ozdenoren, Oleg Rubanov
Publication Date: October 2017
Keyword(s):
JEL(s):
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12355

We model a firm as a team production process subject to moral hazard and derive the optimal profit sharing scheme between productive workers and outside investors together with incentive contracts based on noisy performance signals. More productive agents with noisier performance signals are more likely to receive shares which can explain why managers are motivated by shares, and law or consulting firms form partnerships. A firm that grows by opening branches is held almost entirely by outside investors when its output noise grows faster than the number of branches. Otherwise, insiders hold substantial amount of a large firm's shares.