A Theory of Managerial Conservatism Arising From Private Information About Job Performance

Abstract

I develop a model of managerial conservatism. The key feature is that a manager's performance is privately observed by her incumbent employer, but not by courts or the broader labor market. This generates an asymmetry in the equilibrium wage path: managers receive small wage increases after unexpectedly strong performance, but large wage reductions after unexpectedly weak performance. In consequence, even risk-neutral managers employed by risk-neutral firms avoid risky actions. Firms face a trade-off between restoring incentives for risky actions and retaining their information rent from private observations of ability.