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Production and hedging implications of executive compensation schemes

  • Akron, Sagi
  • Benninga, Simon
Registered author(s):

    This paper connects executive compensation with hedging and analyzes a crucial shareholders and managers agency source that evolves from the pricing of the hedging device. The shareholders are risk-neutral, while the risk-averse manager hedges the price risk of the manufactured quantity, and his compensation package includes equity-linked compensation-stock grants. Only when the hedging instrument's pricing includes a risk premium, hedging is costly to the shareholders, while it is costless to the manager. Then from the owners' point of view, we observe managerial over-hedging, increasing in the equity-linked compensation level. This result leads to a violation of the classical production and hedging separation theorem. We conclude that, in the case where the hedging device's pricing bears a risk premium, shareholders can regulate the corporate value diversion to managers through diminishing the managerial equity-linked compensation scheme or by putting restrictions on the extent of hedging activities of executives.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0929119912001034
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    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 19 (2013)
    Issue (Month): C ()
    Pages: 119-139

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    Handle: RePEc:eee:corfin:v:19:y:2013:i:c:p:119-139
    DOI: 10.1016/j.jcorpfin.2012.10.004
    Contact details of provider: Web page: http://www.elsevier.com/locate/jcorpfin

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