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Dynamic risk taking with bonus schemes

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  • Dietmar P.J. Leisen

Abstract

This paper studies dynamic risk taking by a risk-averse manager who receives a bonus; the company may default on its contractual obligations (debt and fixed compensation). We show that risk taking is time independent, and is summarized by the so-called risk aversion of derived utility. We highlight the importance of dynamic aspects and provide a foundation for common qualitative discussions that are based on characteristics of bonus functions. The paper cautions that deferral of fixed compensation may increase risk taking. Finally, we motivate a new bonus scheme that incentivizes the manager to implement the socially optimal risk level.

Suggested Citation

  • Dietmar P.J. Leisen, 2015. "Dynamic risk taking with bonus schemes," Quantitative Finance, Taylor & Francis Journals, vol. 15(9), pages 1583-1596, September.
    • Handle: RePEc:taf:quantf:v:15:y:2015:i:9:p:1583-1596
    DOI: 10.1080/14697688.2014.969299
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    References listed on IDEAS

    as
    1. Patrick Bolton & Hamid Mehran & Joel Shapiro, 2015. "Executive Compensation and Risk Taking," Review of Finance, European Finance Association, vol. 19(6), pages 2139-2181.
    2. Chenyang Wei & David Yermack, 2010. "Deferred compensation, risk, and company value: investor reactions to CEO incentives," Staff Reports 445, Federal Reserve Bank of New York.
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    Cited by:

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      • Renée B Adams & Roman Kräussl & Marco Navone & Patrick Verwijmeren, 2021. "Gendered Prices," Published Paper Series 2021-4, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    2. Venables, Anthony J., 2017. "Breaking into tradables: Urban form and urban function in a developing city," Journal of Urban Economics, Elsevier, vol. 98(C), pages 88-97.
    3. Chen, An & Hieber, Peter & Nguyen, Thai, 2019. "Constrained non-concave utility maximization: An application to life insurance contracts with guarantees," European Journal of Operational Research, Elsevier, vol. 273(3), pages 1119-1135.

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