The effect of risk preferences on the valuation and incentives of compensation contracts
AbstractWe use a comparative approach to study the incentives provided by di erent types of compensation contracts, and their valuation by risk averse managers, in a fairly general setting. We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. Thus, prudence can contribute to explain the prevalence of stock-options in executive compen- sation. We also present a condition on the utility function which enables to compare the structure of optimal contracts associated with di erent risk preferences.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp697.
Date of creation: Jan 2012
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-04-10 (All new papers)
- NEP-BEC-2012-04-10 (Business Economics)
- NEP-HRM-2012-04-10 (Human Capital & Human Resource Management)
- NEP-MIC-2012-04-10 (Microeconomics)
- NEP-UPT-2012-04-10 (Utility Models & Prospect Theory)
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