The Paradox of Insider Information and Performance Pay

Empirically, managers benefi…t from their …firm's good fortune through their compensation package, and by trading their firm's securities. This practice could easily be eliminated by the board of directors. Theoretically, managers should not pro…t from changes in the …firm's value if there is only private information in the model. Moral hazard explains the paradox of insider information and performance pay. Shareholders permit managers to exploit hidden information in order to incentivize their work activities. The estimated benefi…ts from designing contracts that depend on abnormal returns far outweigh projected savings in lower compensation from paying managers …fixed wages.