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Reining in Excessive Risk Taking by Executives : Experimental Evidence

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Author Info

  • Mathieu Lefebvre

    ()
    (University of Liège, CREPP; Boulevard du Rectorat, 7 Bâtiment 31, boîte 39, 4000 Liège, Belgium)

  • Ferdinand M. Vieider

    ()
    (GATE, CNRS UMR 5824 - Université de Lyon, 93 Chemin des Mouilles - B.P. 167, 69131 Ecully Cedex, France)

Abstract

Compensation of executives by means of equity has long been seen as a means to tie executives? income to company performance, and thus as a solution to the principal-agent dilemma created by the separation of ownership and management in publicly owned companies. The overwhelming part of such equity compensation is currently provided in the form of stock-options. Recent events have however revived suspicions that the latter may induce excessive risk taking by executives. In an experiment, we find that subjects acting as executives do indeed take risks that are excessive from the perspective of shareholders if compensated through options. Comparing compensation mechanisms based on stock-options to long-term stock-ownership plans, we find that the latter significantly reduce the uptake of excessive risks by aligning the executives? interests with those of shareholders. Introducing an institutionalized accountability mechanism consisting in the requirement for executives to justify their choices in front of a shareholder reunion also reduces excessive risk taking, and appears to be even more effective than long-term stock-ownership plans. A combination of long-term stock-ownership plans and increased accountability thus seem a promising direction for reining in excessive risk taking by executives.

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Bibliographic Info

Paper provided by Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure in its series Working Papers with number 1006.

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Length: 36 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:gat:wpaper:1006

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Keywords: executive compensation; stock-options; incentives; accountability; risk taking;

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Cited by:
  1. Pahlke, Julius & Strasser, Sebastian & Vieider, Ferdinand M., 2010. "Responsibility Effects in Decision Making under Risk," Discussion Papers in Economics 12115, University of Munich, Department of Economics.
  2. Tetlock, Philip E. & Vieider, Ferdinand M. & Patil, Shefali V. & Grant, Adam M., 2013. "Accountability and ideology: When left looks right and right looks left," Organizational Behavior and Human Decision Processes, Elsevier, vol. 122(1), pages 22-35.

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