Managerial Beliefs and the Cross-Section of Incentives and Compensation

We link a novel dataset on subjective managerial beliefs to empirical evidence on executive compensation and corporate policies through the lens of a structural model. Our data, based on surveys of US managers, reveal rich cross-sectional heterogeneity in subjective managerial beliefs regarding the distribution of sales growth. Forecast errors suggest that managers are on average overconfident. Our model of executive compensation, based on an optimal contract with managers in a setting with moral hazard, identifies managerial beliefs as an important determinant of the key theoretical state variable for contracts, namely promised utility. In the optimal contract, managers' incentives are aligned by promising them continuation payoffs that, because of dynamic incentive compatibility, have to be in line with managers' subjective expectations. Empirically, we can evaluate our dynamic agency model by mapping variation in subjective beliefs to continuation utilities and characteristics of managerial compensation and corporate policies. Our quantitative analysis suggests strong links between managerial biases and executive compensation. In counterfactuals, we use our model to evaluate the implications of aligning managers' beliefs with those of shareholders for compensation and policies.