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Industrial Structure, Executives' Pay And Myopic Risk Taking

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  • John Thanassoulis

Abstract

This study outlines a new theory linking industrial structure to optimal employment contracts and value reducing risk taking.� Firms hire their executives using optimal contracts derived within a competitive labour market.� To motivate effort firms must use some variable remuneration.� Such remuneration introduces a myopic risk taking problem: an executive would wish to inflate early expected earnings at some risk to future profits.� To manage this some bonus pay is deferred.� Convergence in size amongst the largest firms makes the cost of managing the myopic risk taking problem grow faster than the cost of managing the moral hazard problem.� Eventually the optimal contract jumps from one achieving zero myopic risk taking to one tolerating the possibility of myopic risk taking.� Under some conditions the industry partititions: the largest firms hire executives on contracts tolerant of myopic risk taking, smaller firms ensure myopia is ruled out.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 571.

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Date of creation: 01 Oct 2011
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Handle: RePEc:oxf:wpaper:571

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Keywords: Myopic risk taking; Moral hazard; Compensation; Bonuses; Bankers' pay; Tail risk; Industrial structure;

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Cited by:
  1. Laux, Volker, 2012. "Stock option vesting conditions, CEO turnover, and myopic investment," Journal of Financial Economics, Elsevier, Elsevier, vol. 106(3), pages 513-526.

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