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Optimal managerial hedging and contracting with self-esteem concerns

Author

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  • Choe, Chongwoo
  • Lien, Donald
  • Yu, Chia-Feng (Jeffrey)

Abstract

Motivated by psychological evidence that self-esteem plays an important role in individual decision-making, this paper studies how self-esteem concerns influence a manager's effort choice and hedging behavior and how a board designs the managerial compensation in response. We show that when the manager has stronger self-esteem concerns, it requires higher managerial ownership to induce effort. In equilibrium, the manager's net hedging position increases with the strength of the manager's self-esteem concerns. Each of managerial hedging and self-esteem concerns added to an otherwise standard agency model increases the equilibrium pay-performance sensitivity. The agency cost increases as the manager's self-esteem concerns become stronger, but the manager's access to hedging opportunities itself does not change the agency cost. We also discuss how our basic model can be extended to account for circumstances under which managerial hedging can affect firm value.

Suggested Citation

  • Choe, Chongwoo & Lien, Donald & Yu, Chia-Feng (Jeffrey), 2015. "Optimal managerial hedging and contracting with self-esteem concerns," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 354-367.
    • Handle: RePEc:eee:reveco:v:37:y:2015:i:c:p:354-367
    DOI: 10.1016/j.iref.2014.12.007
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    More about this item

    Keywords

    Managerial hedging; Executive compensation; Self-esteem; Agency cost;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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