Moral Hazard, Effort Sensitivity and Compensation
in Asset-Backed Securitization
Seow Eng Ong
Tien Foo Sing
Springer Science + Business Media, Inc. 2006
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.
Keywords Moral hazard
Asset-backed securitization (ABS) is a ﬁnancial innovation whereby debt instru-
ments backed by cash ﬂows generated from revenue-producing assets are converted
into marketable securities and offered for investment purposes in the capital
markets. Over the past two decades, ABS has developed remarkably, in particular
in the US, and has grown into an alternative, attractive important source of funds in
the capital markets. Many income-producing assets such as credit card receivables,
J Real Estate Finan Econ (2006) 32: 229–251
G.-Z. Fan ())
Department of Real Estate, National University of Singapore,
4 Architecture Drive, Singapore 117566, Singapore