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Executive Short-Term Incentive, Risk-Taking And Leverage-Neutral Incentive Scheme

Author

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  • GUY KAPLANSKI

    () (Faculty of Social Sciences, School of Business Administration, Bar-Ilan University, Ramat-Gan 52900, Israel)

  • HAIM LEVY

    () (The Hebrew University of Jerusalem and The Center for Law and Business, Israel)

Abstract

In 23 out of 26 US industries, the annual CEO bonus is larger than the annual salary, suggesting that the bonus strongly affects the CEO's decisions. As the high leverage of financial institutions is often blamed for the 2008 financial crises, in this study we focus on leverage as a factor determining risk, particularly in financial institutions. The typical bonus scheme is not a leverage-neutral bonus scheme (LNBS), as the agent's optimal policy is to employ a corner solution: either zero or exteremely high leverage. Thus, consistent with Ross (2004), the bonus scheme does not neccesarily induce the agent to take greater risks. However, although more leverage is not prefered by all preferences, in most cases it is prefered. Thus, we suggest a combination of incentive parameters, which makes the agent indifferent to leverage, thereby preventing conflict beween the agent and the principal (stockholders).

Suggested Citation

  • Guy Kaplanski & Haim Levy, 2012. "Executive Short-Term Incentive, Risk-Taking And Leverage-Neutral Incentive Scheme," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 7(01), pages 1-45.
  • Handle: RePEc:wsi:afexxx:v:07:y:2012:i:01:n:s2010495212500030
    DOI: 10.1142/S2010495212500030
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    References listed on IDEAS

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    1. Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, Oxford University Press, vol. 125(4), pages 1769-1820.
    2. Bebchuk, Lucian Arye & Fried, Jesse M. & Walker, David I., 2001. "Executive Compensation in America: Optimal Contracting or Extraction of Rents?," Berkeley Olin Program in Law & Economics, Working Paper Series qt1x24r7st, Berkeley Olin Program in Law & Economics.
    3. Bierens,Herman J., 2005. "Introduction to the Mathematical and Statistical Foundations of Econometrics," Cambridge Books, Cambridge University Press, number 9780521834315, December.
    4. Manoj P. K, 2007. "ICT Industry In India: A Swot Analysis," Journal of Global Economy, Research Centre for Social Sciences,Mumbai, India, vol. 3(4), pages 263-278, December.
    5. Bebchuk, Lucian Arye & Fried, Jesse & Walker, David I, 2001. "Executive Compensation in America: Optimal Contracting or Extraction of Rents," CEPR Discussion Papers 3112, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    2. Rui R. Zhao, 2008. "All-or-Nothing Monitoring," American Economic Review, American Economic Association, vol. 98(4), pages 1619-1628, September.

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    More about this item

    Keywords

    Executive compensations; leverage-neutral bonus scheme; bonus cap; risk-taking; JEL Classifications: G3; JEL Classifications: G38; JEL Classifications: J33; JEL Classifications: M52;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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