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CEO compensation and corporate risk: Evidence from a natural experiment

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  • Gormley, Todd A.
  • Matsa, David A.
  • Milbourn, Todd
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    Abstract

    This paper examines the two-way relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms' business risks. The natural experiment provides an opportunity to examine two classic questions related to incentives and risk—how boards adjust incentives in response to firms' risk and how these incentives affect managers' risk-taking. We find that, after left-tail risk increases, boards reduce managers' exposure to stock price movements and that less convexity from options-based pay leads to greater risk-reducing activities. Specifically, managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Accounting and Economics.

    Volume (Year): 56 (2013)
    Issue (Month): 2 ()
    Pages: 79-101

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    Handle: RePEc:eee:jaecon:v:56:y:2013:i:2:p:79-101

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

    Related research

    Keywords: Legal liability; Regulatory risk; Tail risk; Stock options; Compensation; Managerial incentives;

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    References

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