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Hedging and accounting-based RPE contracts for powerful CEOs

Author

Listed:
  • Viktoria Diser

    (Wacker Chemie AG)

  • Christian Hofmann

    (LMU Munich)

Abstract

Several firms prohibit their CEOs from trading in the stock of peer firms. This is puzzling since hedging by the CEO through private trading in the capital market can reduce the CEO’s exposure to systematic compensation risk. When the CEO’s incentive contract comprises relative performance evaluation, we find that the firm might want to disallow private hedging even though there are no technological interdependencies or strategic interactions to peer firms. In the analysis, we highlight two frequently observed characteristics of incentive contracts. First, the use of accounting benchmarks is widespread in compensation contracts for CEOs. Second, empirical and anecdotal evidence suggests that powerful CEOs have influence on the process of designing their own compensation. We find that in the presence of a powerful CEO, the firm can benefit from disallowing private hedging. In particular, the firm’s decision to allow or to disallow private hedging depends on the characteristics of the accounting benchmarks and the characteristics of the peer firms.

Suggested Citation

  • Viktoria Diser & Christian Hofmann, 2018. "Hedging and accounting-based RPE contracts for powerful CEOs," Journal of Business Economics, Springer, vol. 88(7), pages 941-970, September.
    • Handle: RePEc:spr:jbecon:v:88:y:2018:i:7:d:10.1007_s11573-018-0907-7
    DOI: 10.1007/s11573-018-0907-7
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    More about this item

    Keywords

    Relative performance evaluation; Hedging; CEO power; Accounting metrics;
    All these keywords.

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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