Yesterday's Heroes: Compensation and Creative Risk-Taking

Working Paper No. 16176 We study the relationship between compensation and risk-taking among finance firms using a neglected insight from principal-agent contracting with hidden action and risk-averse agents. If the sensitivity of pay to stock price or slope does not vary with stock price volatility...

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Bibliographic Details
Published inNBER Working Paper Series p. 16176
Main Authors Ing-Haw Cheng, Harrison, Hong, Scheinkman, Jose A
Format Paper
LanguageEnglish
Published Cambridge National Bureau of Economic Research, Inc 01.07.2010
Subjects
Central banks
Economic theory
Executive compensation
Incentives
Investments
Rationality
Risk aversion
Stock prices
Stockholders
Volatility
Wages & salaries
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Summary:Working Paper No. 16176 We study the relationship between compensation and risk-taking among finance firms using a neglected insight from principal-agent contracting with hidden action and risk-averse agents. If the sensitivity of pay to stock price or slope does not vary with stock price volatility, then total compensation has to increase with firm risk to satisfy as agent's individual rationality constraint. Consistent with this hypothesis, we find a correlation between total executive compensation, controlling for firm size, and risk measures such as firm beta, return volatility, and exposure to the ABX sub-prime index. There is no relationship between insider ownership, a proxy for slope, and these measures. Compensation and firm risk are not related to governance variables. They increasewith institutional investor ownership, which suggests that heterogeneous investors incentivize firms to take varying levels of risks. Our results hold for non-finance firms and point to newprincipal-agent contracting empirics.
ISSN:0898-2937
DOI:10.3386/w16176