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The effect of risk preferences on the valuation and incentives of compensation contracts

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  • Chaigneau, Pierre

Abstract

We use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by risk averse managers, in a fairly general setting. We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. Thus, prudence can contribute to explain the prevalence of stock-options in executive compensation. We also present a condition on the utility function which enables to compare the structure of optimal contracts associated with different risk preferences.

Suggested Citation

  • Chaigneau, Pierre, 2012. "The effect of risk preferences on the valuation and incentives of compensation contracts," LSE Research Online Documents on Economics 119055, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:119055
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    File URL: http://eprints.lse.ac.uk/119055/
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    executive compensation; principal-agent model; risk preferences; stock-options;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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