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Relative Wealth Concerns, Executive Compensation, and Managerial Risk-Taking

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  • Qi Liu
  • Bo Sun

Abstract

This paper theoretically examines how relative wealth concerns affect equilibrium contracting and systemic risk-taking. We find that such externalities can generate pay for luck as an equilibrium strategy. In expectation of pay for luck in other firms, tying managerial pay to luck provides insurance to managers against a compensation shortfall relative to executive peers. We also show that an effort-inducing mechanism exists: managers have additional incentives to exert effort in utilizing investment opportunities, which helps them keep up with their peers during industry movements; however, pay for luck that is efficient within firms can nonetheless exacerbate aggregate fluctuations, especially during periods of heightened market risk.

Suggested Citation

  • Qi Liu & Bo Sun, 2023. "Relative Wealth Concerns, Executive Compensation, and Managerial Risk-Taking," American Economic Journal: Microeconomics, American Economic Association, vol. 15(2), pages 568-598, May.
    • Handle: RePEc:aea:aejmic:v:15:y:2023:i:2:p:568-98
    DOI: 10.1257/mic.20200325
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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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