Yesterday's Heroes: Compensation and Risk at Financial Firms
53 Pages Posted: 11 Nov 2009 Last revised: 31 May 2014
Date Written: March 24, 2014
Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take creative risks before the Financial Crisis of 2008. We argue instead that even in a classical principal-agent setting without entrenchment and with exogenous firm-risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes born by risk-averse managers. We confirm our conjecture by using lagged stock return volatility to measure exogenous firm risk and showing that riskier firms are also more productive and are more likely to be held by institutional investors, who are most able to influence compensation.
Keywords: financial crisis, executive compensation
JEL Classification: G2, G34
Suggested Citation: Suggested Citation