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The prevention of excess managerial risk taking

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  • Van Wesep, Edward D.
  • Wang, Sean

Abstract

Executives with poor prior performance may be inclined to take excessive risk in the hope of meeting performance targets, in which case a compensation contract featuring severance pay can be optimal. While prior work has shown that severance can induce managers to take positive NPV risks, we show that it can also keep them from taking negative NPV risks. We show that severance should be contingent on results: complete failure should nullify any payments. We also show that mandating a firm size that is larger than first-best, while costly, can help screen for good managers.

Suggested Citation

  • Van Wesep, Edward D. & Wang, Sean, 2014. "The prevention of excess managerial risk taking," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 579-593.
    • Handle: RePEc:eee:corfin:v:29:y:2014:i:c:p:579-593
    DOI: 10.1016/j.jcorpfin.2013.04.008
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    References listed on IDEAS

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    Cited by:

    1. Keiichi Hori & Hiroshi Osano, 2017. "Agency Contracts, Noncommitment Timing Strategies and Real Options," The Japanese Economic Review, Springer, vol. 68(4), pages 521-554, December.
    2. Brown, Kareen & Jha, Ranjini & Pacharn, Parunchana, 2015. "Ex ante CEO severance pay and risk-taking in the financial services sector," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 111-126.
    3. Catarina Fernandes & Jorge Farinha & Francisco Vitorino Martins & Cesario Mateus, 2021. "The impact of board characteristics and CEO power on banks’ risk-taking: stable versus crisis periods," Journal of Banking Regulation, Palgrave Macmillan, vol. 22(4), pages 319-341, December.
    4. Gillan, Stuart L. & Nguyen, Nga Q., 2016. "Incentives, termination payments, and CEO contracting," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 445-465.
    5. Edward D. Van Wesep & Brian Waters, 2022. "Bonus Season: A Theory of Periodic Labor Markets and Coordinated Bonuses," Management Science, INFORMS, vol. 68(7), pages 5464-5492, July.
    6. Brown, Kareen & Pacharn, Parunchana & Patterson, Evelyn, 2022. "Managerial replacement strategies and severance pay," Advances in accounting, Elsevier, vol. 56(C).
    7. Eitan Moshe Goldman & Peggy Peiju Huang, 2015. "Contractual vs. Actual Separation Pay Following CEO Turnover," Management Science, INFORMS, vol. 61(5), pages 1108-1120, May.
    8. Panta, Humnath, 2020. "Does social capital influence corporate risk-taking?," Journal of Behavioral and Experimental Finance, Elsevier, vol. 26(C).

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    More about this item

    Keywords

    Severance pay; Executive compensation; Empire building;
    All these keywords.

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M55 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Labor Contracting Devices

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