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Competitive Pay and Excessive Manager Risk-taking

Author

Listed:
  • Jen-Wen Chang

    () (California State University, Fullerton)

  • Simpson Zhang

    () (Office of Financial Research)

Abstract

Since the 2007-09 financial crisis, researchers have debated whether compensation plans drove excessive risk-taking or financial managers simply underestimated the risks of various investments. Through a principal-agent model with heterogeneous beliefs, we show that principals offer contracts that incentivize safe behavior when competition for managerial talent is low. However, intense competition results in contracts that incentivize risk-taking. We find that factors that increase the intensity of competition include greater search efficiency, larger project scales, and higher debt funding, all of which may be prevalent during a financial bubble.

Suggested Citation

  • Jen-Wen Chang & Simpson Zhang, 2018. "Competitive Pay and Excessive Manager Risk-taking," Working Papers 18-02, Office of Financial Research, US Department of the Treasury.
  • Handle: RePEc:ofr:wpaper:18-02
    as

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    File URL: https://www.financialresearch.gov/working-papers/files/OFRwp-18-02_Competitive-Pay-and-Excessive-Manager-Risk-taking.pdf
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    References listed on IDEAS

    as
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    Keywords

    competition; compensation constracts; overoptimism;

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