TY - JOUR T1 - What Steve Ross Taught Me about Contracting JF - The Journal of Portfolio Management SP - 35 LP - 41 DO - 10.3905/jpm.2018.44.6.035 VL - 44 IS - 6 AU - Philip H. Dybvig Y1 - 2018/06/30 UR - https://pm-research.com/content/44/6/35.abstract N2 - Stephen A. Ross may be best known in finance for his work on asset pricing, but he is also the first person in economics or finance to study agency theory as a theory of incentive contracting, as for a portfolio manager or the CEO or other employee of a firm. This article, written by Professor Ross’s doctoral student and subsequent colleague and co-author at Yale University, looks at some lessons we can learn from Ross’s work in agency theory. Incentive contracting involves a trade-off between incentives and risk sharing. Traditional performance measures such as Jensen’s alpha and the Sharpe ratio can fail for market timers, and convex compensation from call or put options does not necessarily increase incentives for risk-taking. Under reasonable assumptions, adding a put option to equity compensation increases incentives for risk-taking, but adding a call option yields ambiguous results.TOPICS: Portfolio theory, quantitative methods, options ER -