Are the shareholders in Japanese governance mechanisms getting a benefit from the use of annual incentive plans?

This paper studies the economic consequences of choosing two differenttypes of executive compensation contracts. The analysis is based on a two-periodagency model in which compensation contracts are subject to renegotiation; compensationis paid based on the agent’s earnings report (e.g., a performance-based contract)or a non-verifiable measure within the firm (e.g., a conventional implicit contract).According to the analysis, conventional implicit contracts can dominate performancebasedcontracts if the non-verifiable measure is sufficiently informative so that theagent’s earnings report is not significantly considered during renegotiation. However,if the agent has strong bargaining power, the performance-based contract is optimal.The theoretical findings have implications for empirical compensation research. First,the firms’ compensation policy may not serve as a useful test for identifying profitablefirms. Second, the combination of the compensation policy and the ownership structureis likely to be associated with the level of executive compensation