Managerial Ownership and Employee Risk Bearing
41 Pages Posted: 15 Jan 2009 Last revised: 14 May 2014
Date Written: February 12, 2010
Executives who own a stake in the firm that they manage tend to be under-diversified and therefore have an incentive to take real actions to smooth earnings. Using a simple principal-agent model, we show that management will use variable pay to transfer risk to employees. The variability of pay used should be increasing in managerial ownership. We find support for this theory in the data: a ten percent increase in executive ownership translates to a 14 percent increase in the variability of option grants per employee and a three percent increase in the variability in employment. That is, when management ownership is higher, employees have a greater risk of being fired and greater variability in pay. Financing constraints also provide a motivation to shift risk to employees. We find that the effect of such constraints may be felt most by employees not via the mix of compensation elements, but via risk of job loss.
Keywords: Compensation, Stock Options, Real Earnings Management, bonus pay
JEL Classification: G34, J33, M55
Suggested Citation: Suggested Citation