The Incentive to 'Bet the Farm': CEO Compensation and Major Investments

55 Pages Posted: 19 Mar 2008 Last revised: 6 Apr 2008

See all articles by Gavin Smith

Gavin Smith

University of New South Wales - School of Banking and Finance

Peter L. Swan

University of New South Wales (UNSW Sydney; Financial Research Network (FIRN)

Date Written: 23 February, 2008

Abstract

Using a matched sample of firms that do and do not undertake major investments we find that CEO incentives with option-based asymmetric payoffs greatly increase the likelihood that a firm will increase risk by undertaking both major real investments and acquisitions. In contrast, equity-based incentives that induce upside and downside symmetric payoffs are associated with fewer major acquisitions and neither encourages nor discourages real investments. Fixed pay is associated with low likelihood of major investments and a poorer prognosis. When option-incentivized CEOs use equity for funding real investment decisions they have the best combination of incentives and funding source.

Keywords: Acquisitions, Capital Expenditures, Incentives, Firm Performance, Risk

JEL Classification: G23, G32, G34, J33

Suggested Citation

Smith, Gavin and Swan, Peter Lawrence, The Incentive to 'Bet the Farm': CEO Compensation and Major Investments (23 February, 2008). Available at SSRN: https://ssrn.com/abstract=1009323 or http://dx.doi.org/10.2139/ssrn.1009323

Gavin Smith

University of New South Wales - School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Peter Lawrence Swan (Contact Author)

University of New South Wales (UNSW Sydney ( email )

School of Banking and Finance
UNSW Business School
Sydney NSW, NSW 2052
Australia
+61 2 9385 5871 (Phone)
+61 2 9385 6347 (Fax)

HOME PAGE: http://https://www.business.unsw.edu.au/our-people/peterswan

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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