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Explaining the Structure of CEO Incentive Pay with Decreasing Relative Risk Aversion

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  • Pierre Chaigneau
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    Abstract

    It is established that the standard principal-agent model cannot explain the structure of commonly used CEO compensation contracts if CRRA preferences are postulated. However, we demonstrate that this model has potentially a high explanatory power with preferences with decreasing relative risk aversion, in the sense that a typical CEO contract is approximately optimal for plausible preference parameters.

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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2012/CIRPEE12-08.pdf
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    Bibliographic Info

    Paper provided by CIRPEE in its series Cahiers de recherche with number 1208.

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    Date of creation: 2012
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    Handle: RePEc:lvl:lacicr:1208

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    Related research

    Keywords: CEO pay; principal-agent model; corporate governance; stock-options;

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    References

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    1. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January.
    2. Matthew Rabin., 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Economics Working Papers E00-279, University of California at Berkeley.
    3. Ogaki, Masao & Zhang, Qiang, 2001. "Decreasing Relative Risk Aversion and Tests of Risk Sharing," Econometrica, Econometric Society, vol. 69(2), pages 515-26, March.
    4. Xavier Gabaix & Augustin Landier, 2008. "Why Has CEO Pay Increased So Much?," The Quarterly Journal of Economics, MIT Press, vol. 123(1), pages 49-100, 02.
    5. Frydman, Carola & Jenter, Dirk, 2010. "CEO Compensation," Research Papers 2069, Stanford University, Graduate School of Business.
    6. Maug, Ernst & Dittmann, Ingolf, 2007. "Lower Salaries and No Options: The Optimal Structure of Executive Pay," Sonderforschungsbereich 504 Publications 07-41, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    7. Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2001. "The Empirical Importance of Precautionary Saving," CEPR Discussion Papers 2737, C.E.P.R. Discussion Papers.
    8. Ingolf Dittmann & Ernst Maug & Oliver Spalt, 2010. "Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse," Journal of Finance, American Finance Association, vol. 65(6), pages 2015-2050, December.
    9. Ingolf Dittmann & Ko-Chia Yu, 2009. "How Important Are Risk-Taking Incentives in Executive Compensation?," Tinbergen Institute Discussion Papers 09-076/2, Tinbergen Institute.
    10. Yacine Ait-Sahalia & Andrew W. Lo, 2000. "Nonparametric Risk Management and Implied Risk Aversion," NBER Working Papers 6130, National Bureau of Economic Research, Inc.
    11. Alex Edmans & Xavier Gabaix & Augustin Landier, 2009. "A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 4881-4917, December.
    12. Barsky, Robert B, et al, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 537-79, May.
    13. Mehran, Hamid, 1995. "Executive compensation structure, ownership, and firm performance," Journal of Financial Economics, Elsevier, vol. 38(2), pages 163-184, June.
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