Abstract

http://ssrn.com/abstract=1988375
 
 

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Risk Aversion, Prudence, and Compensation


Pierre Chaigneau


HEC Montreal

February 1, 2014


Abstract:     
In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function $u$ who are risk averse (u'' < 0) and prudent (u''' > 0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, prudence can contribute to explain the prevalence of stock-options in executive compensation.

Number of Pages in PDF File: 22

Keywords: downside risk, executive compensation, principal-agent model, prudence, risk preferences, stock-options

JEL Classification: D80, D86, J33

working papers series


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Date posted: January 19, 2012 ; Last revised: February 2, 2014

Suggested Citation

Chaigneau, Pierre, Risk Aversion, Prudence, and Compensation (February 1, 2014). Available at SSRN: http://ssrn.com/abstract=1988375 or http://dx.doi.org/10.2139/ssrn.1988375

Contact Information

Pierre Chaigneau (Contact Author)
HEC Montreal ( email )
3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
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