Managerial compensation with hyperbolic discounting

This paper characterizes the optimal performance-based compensation plan for alignment by incorporating time inconsistent preferences. When investment payoffs are given in flow terms, the presence of time-inconsistency enhances the fraction of the cash flows the manager should receive and delays investment. However, in the lump-sum payoff case, the smaller the time inconsistency, the higher the value-sharing bonus needed for aligning interests with the managers and the earlier the investment exercise. Furthermore, we find that the parameters describing the project value also matter for the optimal contract scheme.