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Risk taking of executives under different incentive contracts: Experimental evidence

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  • Lefebvre, Mathieu
  • Vieider, Ferdinand M.

Abstract

Classic financial agency theory recommends compensation through stock options rather than shares to counteract excessive risk aversion in agents. In a setting where any kind of risk taking is suboptimal for shareholders, we show that excessive risk taking may occur for one of two reasons: risk preferences or incentives. Even when compensated through restricted company stock, experimental CEOs take large amounts of excessive risk. This contradicts classical financial theory, but can be explained through risk preferences that are not uniform over the probability and outcome spaces, and in particular, risk seeking for small probability gains and large probability losses. Compensation through options further increases risk taking as expected. We show that this effect is driven mainly by the personal asset position of the experimental CEO, thus having deleterious effects on company performance.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

Volume (Year): 97 (2014)
Issue (Month): C ()
Pages: 27-36

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Handle: RePEc:eee:jeborg:v:97:y:2014:i:c:p:27-36

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

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Keywords: Executive compensation; Risk preferences; Experimental finance; Prospect theory;

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Cited by:
  1. Mathieu Lefebvre & Ferdinand Vieider, 2013. "Reining in excessive risk-taking by executives: the effect of accountability," Theory and Decision, Springer, vol. 75(4), pages 497-517, October.
  2. Andersson, Ola & Holm, Håkan J. & Tyran, Jean-Robert & Wengström, Erik, 2013. "Risking Other People’s Money: Experimental Evidence on Bonus Schemes, Competition, and Altruism," Working Paper Series 989, Research Institute of Industrial Economics.

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