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Yesterday's Heroes: Compensation and Risk at Financial Firms

53 Pages Posted: 11 Nov 2009 Last revised: 31 May 2014

Ing-Haw Cheng

Tuck School of Business at Dartmouth

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Jose A. Scheinkman

Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: March 24, 2014

Abstract

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

Cheng, Ing-Haw and Hong, Harrison G. and Scheinkman, Jose A., Yesterday's Heroes: Compensation and Risk at Financial Firms (March 24, 2014). ECGI - Finance Working Paper No. 285/2010; AFA 2011 Denver Meetings Paper; ECGI - Finance Working Paper No. 285/2010. Available at SSRN: https://ssrn.com/abstract=1502762

Ing-Haw Cheng

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States

Harrison G. Hong (Contact Author)

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jose A. Scheinkman

Columbia University ( email )

420 W. 118th Street
New York, NY 10027
United States

HOME PAGE: http://www.princeton.edu/~joses

Princeton University - Department of Economics ( email )

26 Prospect Avenue
Princeton, NJ 08544
United States
609-258-4020 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://www.princeton.edu/~joses

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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