The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation
AbstractThe principal-agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance, yet the existing empirical evidence supporting it is quite weak. The key predication of the model is that the executive's pay-performance sensitivity is decreasing in the variance of the firm's performance. We demonstrate strong empirical confirmation of this prediction using a comprehensive sample of executives at large corporations. In general, the pay-performance sensitivity for executives at firms with the least volatile stock prices is an order of magnitude greater than the pay-performance sensitivity for executives at firms with the most volatile stock prices. This result holds for both chief executive officers and for other highly compensated executives. We further show that estimates of the pay-performance sensitivity that do not explicitly account for the effect of the variance of firm performance are biased toward zero. We also test for relative performance evaluation of executives against the performance of other firms. We find little support for the relative performance evaluation model. Our findings suggest that executive compensation contracts incorporate the benefits of risk-sharing but do not incorporate the potential informational advantages of relative performance evaluation.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6634.
Date of creation: Jul 1998
Date of revision:
Note: AP CF LS
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
Other versions of this item:
- Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February.
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Barro, Jason R. & Barro, Robert J., 1990.
"Pay, Performance, and Turnover of Bank CEOs,"
3451300, Harvard University Department of Economics.
- Joseph G. Haubrich, 1991.
"Risk aversion, performance pay, and the principal-agent problem,"
9118, Federal Reserve Bank of Cleveland.
- Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April.
- Shleifer, Andrei & Vishny, Robert W, 1997.
" A Survey of Corporate Governance,"
Journal of Finance,
American Finance Association, vol. 52(2), pages 737-83, June.
- Andrei Shleifer & Robert W. Vishny, 1996. "A Survey of Corporate Governance," NBER Working Papers 5554, National Bureau of Economic Research, Inc.
- Andrei Shleifer & Robert W. Vishny, 1995. "A Survey of Corporate Governance," Harvard Institute of Economic Research Working Papers 1741, Harvard - Institute of Economic Research.
- Bengt Holmstrom, 1981.
"Moral Hazard in Teams,"
471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Holmstrom, Bengt & Milgrom, Paul, 1987.
"Aggregation and Linearity in the Provision of Intertemporal Incentives,"
Econometric Society, vol. 55(2), pages 303-28, March.
- Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
- Koenker, Roger & Bassett, Gilbert, Jr, 1982. "Robust Tests for Heteroscedasticity Based on Regression Quantiles," Econometrica, Econometric Society, vol. 50(1), pages 43-61, January.
- Moshe Buchinsky, 1998. "Recent Advances in Quantile Regression Models: A Practical Guideline for Empirical Research," Journal of Human Resources, University of Wisconsin Press, vol. 33(1), pages 88-126.
- Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December.
- William Gould, 1993. "Quantile regression with bootstrapped standard errors," Stata Technical Bulletin, StataCorp LP, vol. 2(9).
- Robert Gibbons & Kevin J. Murphy, 1990. "Relative performance evaluation for chief executive officers," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 43(3), pages 30-51, February.
- Bengt Holmstrom, 1979.
"Moral Hazard and Observability,"
Bell Journal of Economics,
The RAND Corporation, vol. 10(1), pages 74-91, Spring.
- Brian J. Hall & Jeffrey B. Liebman, 1998.
"Are CEOs Really Paid Like Bureaucrats?,"
The Quarterly Journal of Economics,
MIT Press, vol. 113(3), pages 653-691, August.
- Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Paid Like Bureaucrats?," Harvard Institute of Economic Research Working Papers 1789, Harvard - Institute of Economic Research.
- Robert Gibbons & Kevin Murphy, 1989.
"Relative Performance Evaluation for Chief Executive Officers,"
628, Princeton University, Department of Economics, Industrial Relations Section..
- Gibbons, R. & Murphy, K.J., 1989. "Relative Performance Evaluation For Chief Executive Officers," Working papers 532, Massachusetts Institute of Technology (MIT), Department of Economics.
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page. reading list or among the top items on IDEAS.Access and download statistics
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.