Risk mitigation in the face of uncertainty: The influence of peer compensation on managerial risk taking

In the face of increased uncertainty, companies use the peer pay effect to mitigate risks by influencing managerial risk-taking behavior. This paper examines whether peer pay affects managerial risk taking in line with the Behavioral Agency Model (BAM). We argue that a higher ret-compensation ratio compared to peer companies diminishes managerial risk taking, thus fostering corporate risk mitigation, and that this effect is amplified by uncertainty. Using a large panel of listed firms, we find that a one-standard-deviation increase in the peer pay gap is associated with an economically meaningful decline in leverage (coefficient approximately −0.006, significant at the 1 % level). We further construct firm-level uncertainty exposure using a Fama–French three-factor augmented model and show that higher exposure strengthens the negative association between peer pay effect and managerial risk taking. Using peer shock as an instrument, our IV estimates confirm the causal effect of peer pay on managerial risk taking. Consequently, this study empirically validates the core proposition of the BAM, offering practical implications for designing executive compensation structures and implementing risk mitigation strategies.