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Production and hedging implications of executive compensation schemes

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  • Akron, Sagi
  • Benninga, Simon
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    Abstract

    This paper connects executive compensation with hedging and analyzes a crucial shareholders and managers agency source that evolves from the pricing of the hedging device. The shareholders are risk-neutral, while the risk-averse manager hedges the price risk of the manufactured quantity, and his compensation package includes equity-linked compensation-stock grants. Only when the hedging instrument's pricing includes a risk premium, hedging is costly to the shareholders, while it is costless to the manager. Then from the owners' point of view, we observe managerial over-hedging, increasing in the equity-linked compensation level. This result leads to a violation of the classical production and hedging separation theorem. We conclude that, in the case where the hedging device's pricing bears a risk premium, shareholders can regulate the corporate value diversion to managers through diminishing the managerial equity-linked compensation scheme or by putting restrictions on the extent of hedging activities of executives.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0929119912001034
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 19 (2013)
    Issue (Month): C ()
    Pages: 119-139

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    Handle: RePEc:eee:corfin:v:19:y:2013:i:c:p:119-139

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    Web page: http://www.elsevier.com/locate/jcorpfin

    Related research

    Keywords: Optimal managerial compensation scheme; Corporate hedging devices; Executive equity-linked compensation; Frictions; Regulation; Separation theorems;

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    Cited by:
    1. Al-Shboul, Mohammad & Anwar, Sajid, 2014. "Foreign exchange rate exposure: Evidence from Canada," Review of Financial Economics, Elsevier, vol. 23(1), pages 18-29.

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