Risk, Managerial Effort and Project Choice
 Journal of Financial Intermediation, (3), (1992):308-45.  The Theory of Corporate Finance, Vol. 1, M.J. Brennan editor, Edward Elgar Publishers, Cheltenham, UK, 1996, pp. 419-58.
Posted: 1 Dec 2008
In our model risk-neutral shareholders need to motivate a manager to select among projects with different risks, and to work hard in implementing the chosen project. Curvature of the manager's compensation contract as a function of profit affects his attitude toward project risk. The optimal curvature depends on the trade-off between controlling project risk and motivating effort. The analysis predicts greater option-based compensation when there are desirable risky growth opportunities (proxied by Tobin's q or R&D expenditures) and less option compensation when there are effective monitoring institutions (such as outside directors and bank lenders).
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