Yesterday’s Heroes: Compensation and Creative Risk-Taking
In: Market Institutions and Financial Market Risk
AbstractWe study the relationship between compensation and risk-taking among finance firms using a neglected insight from principal-agent contracting with hidden action and risk-averse agents. If the sensitivity of pay to stock price or slope does not vary with stock price volatility, then total compensation has to increase with firm risk to satisfy as agent's individual rationality constraint. Consistent with this hypothesis, we find a correlation between total executive compensation, controlling for firm size, and risk measures such as firm beta, return volatility, and exposure to the ABX sub-prime index. There is no relationship between insider ownership, a proxy for slope, and these measures. Compensation and firm risk are not related to governance variables. They increasewith institutional investor ownership, which suggests that heterogeneous investors incentivize firms to take varying levels of risks. Our results hold for non-finance firms and point to newprincipal-agent contracting empirics.
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- Ing-Haw Cheng & Harrison Hong & Jose A. Scheinkman, 2010. "Yesterday's Heroes: Compensation and Creative Risk-Taking," NBER Working Papers 16176, National Bureau of Economic Research, Inc.
- G01 - Financial Economics - - General - - - Financial Crises
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- 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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- Adrian, Tobias & Shin, Hyun Song, 2010.
"Liquidity and leverage,"
Journal of Financial Intermediation, Elsevier,
Elsevier, vol. 19(3), pages 418-437, July.
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