Abstract

http://ssrn.com/abstract=1502762
 
 

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Yesterday's Heroes: Compensation and Risk at Financial Firms


Ing-Haw Cheng


Dartmouth College - Tuck School of Business

Harrison G. Hong


Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Jose A. Scheinkman


Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

December 27, 2013

AFA 2011 Denver Meetings Paper
ECGI - Finance Working Paper No. 285/2010

Abstract:     
Many believe that compensation, misaligned from shareholder value due to managerial entrenchment, caused some financial firms to take creative risks before the Financial Crisis of 2008. We argue instead that pay and risk can be correlated even in a classical principal-agent setting where entrenchment is absent and firm risk is exogenous. To incentivize managers, shareholders give them ownership stakes. For the same stake, risk-averse managers at riskier firms face greater wealth uncertainty since their stock prices are more volatile. They then need to receive greater total pay to compensate them for bearing extra risk. Using lagged stock return volatility, even back to when a firm first goes public, as a measure of exogenous firm risk, we confirm our conjecture that firm risk leads to pay. We also find that institutional investors, who are most likely to be able to influence managers and understand company risks, were more likely to hold riskier finance firms.

Number of Pages in PDF File: 49

Keywords: financial crisis, executive compensation

JEL Classification: G2, G34

Accepted Paper Series


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Date posted: November 11, 2009 ; Last revised: December 28, 2013

Suggested Citation

Cheng, Ing-Haw and Hong, Harrison G. and Scheinkman, Jose A., Yesterday's Heroes: Compensation and Risk at Financial Firms (December 27, 2013). ECGI - Finance Working Paper No. 285/2010; AFA 2011 Denver Meetings Paper; ECGI - Finance Working Paper No. 285/2010. Available at SSRN: http://ssrn.com/abstract=1502762

Contact Information

Ing-Haw Cheng
Dartmouth College - Tuck School of Business ( email )
Hanover, NH 03755
United States
Harrison G. Hong (Contact Author)
Princeton University - Department of Economics ( email )
Princeton, NJ 08544-1021
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Jose A. Scheinkman
Columbia University ( email )
420 W. 118th Street
New York, NY 10027
United States
HOME PAGE: http://www.princeton.edu/~joses
Princeton University - Department of Economics ( email )
26 Prospect Avenue
Princeton, NJ 08544
United States
609-258-4020 (Phone)
609-258-6419 (Fax)
HOME PAGE: http://www.princeton.edu/~joses

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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