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Managerial Compensation under Privately-Observed Hedging


  • Qi Liu
  • Bo Sun


This paper studies how private information in hedging outcomes affects the design of managerial compensation when hedging instruments serve as a double-edged sword in that they may be used for both corporate hedging and earnings management. On the one hand, financial vehicles can offer customized contracts that are closely tailored to manage specific risk and improve hedging efficiency. On the other hand, involvement in hedging may give rise to manipulation through misstatement of the value estimates. We show that the use of privately-observed hedging may actually require greater pay-for-performance in managerial compensation. The cross-sectional variations in managerial compensation lend support to our model.

Suggested Citation

  • Qi Liu & Bo Sun, 2016. "Managerial Compensation under Privately-Observed Hedging," International Finance Discussion Papers 1160, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:1160
    DOI: 10.17016/IFDP.2016.1160

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    References listed on IDEAS

    1. Lacker, Jeffrey M & Weinberg, John A, 1989. "Optimal Contracts under Costly State Falsification," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1345-1363, December.
    2. Lin Nan, 2008. "The Agency Problems of Hedging and Earnings Management," Contemporary Accounting Research, John Wiley & Sons, vol. 25(3), pages 859-890, September.
    3. Rogers, Daniel A., 2002. "Does executive portfolio structure affect risk management? CEO risk-taking incentives and corporate derivatives usage," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 271-295, March.
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    5. Sun, Bo, 2014. "Executive compensation and earnings management under moral hazard," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 276-290.
    6. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    7. Chernenko, Sergey & Faulkender, Michael, 2011. "The Two Sides of Derivatives Usage: Hedging and Speculating with Interest Rate Swaps," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(6), pages 1727-1754, December.
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    More about this item


    Managerial compensation; Corporate hedging;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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