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Managerial responses to incentives: Control of firm risk, derivative pricing implications, and outside wealth management

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  • Hodder, James E.
  • Jackwerth, Jens Carsten

Abstract

We model a firm's value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also controls allocation of his outside wealth, which allows partially hedging of his exposure to firm risk. Managerial control increases the expected time to exercise for his employee stock options. It also reduces the gap between his certainty equivalent and the firm's Fair Value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile. With costly control the same basic patterns remain, but the manager's risk-taking is dampened.

Suggested Citation

  • Hodder, James E. & Jackwerth, Jens Carsten, 2011. "Managerial responses to incentives: Control of firm risk, derivative pricing implications, and outside wealth management," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1507-1518, June.
    • Handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1507-1518
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    Cited by:

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    More about this item

    Keywords

    Optimal risk-taking Managerial control Derivatives;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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