Executive Short-Term Incentive, Risk-Taking and Leverage-Neutral Incentive Scheme

Annals of Financial Economics (AFE), Vol. 7, Issue 1, pp. 1250003-1:45, 2012

64 Pages Posted: 22 Jul 2009 Last revised: 29 Sep 2013

Guy Kaplanski

Bar-Ilan University - Graduate School of Business Administration

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration; Fordham University

Date Written: January 7, 2011

Abstract

In 23 out of 26 U.S. industries, the annual CEO bonus is larger than the annual salary, suggesting that the bonus strongly affects the CEO’s decisions. As the high leverage of financial institutions is often blamed for the 2008 financial crises, in this study we focus on leveragre as a factor determining risk, particularly in finnacial institutuions. The typical bonus scheme is not a leverage-neutral bonus scheme (LNBS), as the agent’s optimal policy is to employ a corner solution: either zero or exteremely high leverage. Thus, consistent with Ross (2004), the bonus scheme does not neccesarily induce the agent to take greater risks. However, although more leverage is not preffered by allpreferences, in most cases it is preffered. Thus, we suggest a combination of incentive parameters, which makes the agent indifferent to leverage, thereby preventing conflict beween the agent and the principal (stockholders).

Keywords: Executive compensation, leverage-neutral bonus scheme, bonus cap, risk-taking

JEL Classification: D2, D3, G38, J33

Suggested Citation

Kaplanski, Guy and Levy, Haim, Executive Short-Term Incentive, Risk-Taking and Leverage-Neutral Incentive Scheme (January 7, 2011). Annals of Financial Economics (AFE), Vol. 7, Issue 1, pp. 1250003-1:45, 2012. Available at SSRN: https://ssrn.com/abstract=1437616 or http://dx.doi.org/10.2139/ssrn.1437616

Guy Kaplanski (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

Ramat Gan
Israel

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

HOME PAGE: http://pluto.huji.ac.il/~mshlevy/

Fordham University ( email )

140 West 62nd Street
New York, NY 10023
United States

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