Incentives, equality and contract renegotiations: Theory and evidence in the chinese banking industry

Abstract

Renegotiation plays an important role in contract theory, but the empirical study of renegotiation is almost non-existent in the literature. Using a unique dataset from the Chinese banking industry, we find that the large majority of managerial incentive contracts are renegotiated after performances are realized. We develop a model of contract renegotiation where supervisors and managers sign incentive contracts and then renegotiate them. In the unique equilibrium of the model, incentive contracts are almost always renegotiated ex post. Even though renegotiation is fully anticipated, incentive contracts affect performance. The predictions of the model find strong support from our empirical results. © 2010 The Authors. Journal compilation © 2010 Blackwell Publishing Ltd. and the Editorial Board of The Journal of Industrial Economics.