Yesterday's Heroes: Compensation and Creative Risk-Taking
We study the relationship between compensation and risk-taking among finance firms using a neglected insight from principal-agent contracting with hidden action and risk-averse agents. If the sensitivity of pay to stock price or slope does not vary with stock price volatility, then total compensation has to increase with firm risk to satisfy as agent's individual rationality constraint. Consistent with this hypothesis, we find a correlation between total executive compensation, controlling for firm size, and risk measures such as firm beta, return volatility, and exposure to the ABX sub-prime index. There is no relationship between insider ownership, a proxy for slope, and these measures. Compensation and firm risk are not related to governance variables. They increasewith institutional investor ownership, which suggests that heterogeneous investors incentivize firms to take varying levels of risks. Our results hold for non-finance firms and point to newprincipal-agent contracting empirics.
|Date of creation:||Jul 2010|
|Publication status:||published as Yesterday's Heroes: Compensation and Creative Risk-Taking , Ing-Haw Cheng, Harrison Hong, Jose Scheinkman. in Market Institutions and Financial Market Risk , Carey, Kashyap, Rajan, and Stulz. 2012|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Adrian, Tobias & Shin, Hyun Song, 2010.
"Liquidity and leverage,"
Journal of Financial Intermediation,
Elsevier, vol. 19(3), pages 418-437, July.
- Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York.
- Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 109-128, Spring.
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