Moral Hazard, Effort Sensitivity and Compensation in Asset-Backed Securitization

Abstract

One interesting explanation for asset securitization is the managerial agency theory—where securitization of cash flows that are relatively insensitive to managerial effort reduces the noise for cash flows that are sensitive to managerial effort (Iacobucci and Winter, 2005). This paper extends this concept in several ways. First, we differentiate the effects of noise and effort sensitivity on managerial effort and compensation, underscoring the importance of a less noisy environment. We also carefully delineate the conditions under which asset securitization would improve the welfare of managers and shareholders of the originating company. Second, we relax the assumptions regarding the expected income-producing function and the income variance, and further take into consideration the change of the marginal production of income with respect to effort before and after securitization. Third, under a multitask principal-agent model framework, we explore how the relationship between managerial activities on different assets affects the incentive compensation for the manager of the originating company and the joint surplus for shareholder and manager. This is particularly relevant when entire buildings are securitized as opposed to pools of income-generating assets. Finally, we examine the role of the third-party servicer.