Yesterday's Heroes: Compensation and Risk at Financial Firms
Tuck School of Business at Dartmouth
Harrison G. Hong
Columbia University, Graduate School of Arts and Sciences, 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)
March 24, 2014
AFA 2011 Denver Meetings Paper
ECGI - Finance Working Paper No. 285/2010
Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take creative risks before the Financial Crisis of 2008. We argue instead that even in a classical principal-agent setting without entrenchment and with exogenous firm-risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes born by risk-averse managers. We confirm our conjecture by using lagged stock return volatility to measure exogenous firm risk and showing that riskier firms are also more productive and are more likely to be held by institutional investors, who are most able to influence compensation.
Number of Pages in PDF File: 53
Keywords: financial crisis, executive compensation
JEL Classification: G2, G34
Date posted: November 11, 2009 ; Last revised: May 31, 2014
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