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Convex payoffs: implications for risk-taking and financial reform

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  • Stephen F. LeRoy

Abstract

Financial executive pay is a convex function of profits if recipients get a greater increment in pay when returns are high as opposed to moderate, compared with when returns are moderate as opposed to low. Convex compensation packages give financial executives incentive to adopt risky investment projects, implement highly levered capital structures, and create new risk. Financial regulators may be able to enforce changes in compensation that would attenuate these adverse effects.

Suggested Citation

  • Stephen F. LeRoy, 2010. "Convex payoffs: implications for risk-taking and financial reform," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue oct4.
  • Handle: RePEc:fip:fedfel:y:2010:i:oct4:n:2010-30
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    References listed on IDEAS

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    1. Raghuram G. Rajan, 2005. "Has financial development made the world riskier?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 313-369.
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    Keywords

    Executives - Salaries;

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