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Explaining the Structure of CEO Incentive Pay with Decreasing Relative Risk Aversion

  • Pierre Chaigneau

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    It is established that the standard principal-agent model cannot explain the structure of commonly used CEO compensation contracts if CRRA preferences are postulated. However, we demonstrate that this model has potentially a high explanatory power with preferences with decreasing relative risk aversion, in the sense that a typical CEO contract is approximately optimal for plausible preference parameters.

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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp693.pdf
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    Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp693.

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    Date of creation: Oct 2011
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    Handle: RePEc:fmg:fmgdps:dp693
    Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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    1. Rabin, Matthew, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Department of Economics, Working Paper Series qt731230f8, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    2. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
    3. Masao Ogaki & Qiang Zhang, 1998. "Decreasing Relative Risk Aversion and Tests of Risk Sharing," Working Papers 98-02, Ohio State University, Department of Economics.
    4. Frydman, Carola & Jenter, Dirk, 2010. "CEO Compensation," Research Papers 2069, Stanford University, Graduate School of Business.
    5. Barsky, Robert B, et al, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 537-79, May.
    6. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc.
    7. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2001. "The Empirical Importance of Precautionary Saving," American Economic Review, American Economic Association, vol. 91(2), pages 406-412, May.
    8. Mehran, Hamid, 1995. "Executive compensation structure, ownership, and firm performance," Journal of Financial Economics, Elsevier, vol. 38(2), pages 163-184, June.
    9. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
    10. Maug, Ernst & Dittmann, Ingolf, 2007. "Lower Salaries and No Options: The Optimal Structure of Executive Pay," Sonderforschungsbereich 504 Publications 07-41, Sonderforschungsbereich 504, Universit├Ąt Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    11. Alex Edmans & Xavier Gabaix & Augustin Landier, 2009. "A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 4881-4917, December.
    12. Ingolf Dittmann & Ernst Maug & Oliver Spalt, 2010. "Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse," Journal of Finance, American Finance Association, vol. 65(6), pages 2015-2050, December.
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