Reining in Excessive Risk Taking by Executives: Experimental Evidence

GATE Working Paper No. 1006

36 Pages Posted: 18 Mar 2010 Last revised: 10 May 2010

See all articles by Mathieu Lefebvre

Mathieu Lefebvre

University of Liege - Research Center on Public and Population Economics

Ferdinand M. Vieider

University of Lyon, CNRS-GATE; German Institute for Economic Research (DIW Berlin); WZB Berlin Social Science Center

Date Written: March 1, 2010

Abstract

Compensation of executives by means of equity has long been seen as a means to tie executives’ income to company performance, and thus as a solution to the principal-agent dilemma created by the separation of ownership and management in publicly owned companies. The overwhelming part of such equity compensation is currently provided in the form of stock-options. Recent events have however revived suspicions that the latter may induce excessive risk taking by executives. In an experiment, we find that subjects acting as executives do indeed take risks that are excessive from the perspective of shareholders if compensated through options. Comparing compensation mechanisms based on stock-options to long-term stock-ownership plans, we find that the latter significantly reduce the uptake of excessive risks by aligning the executives’ interests with those of shareholders. Introducing an institutionalized accountability mechanism consisting in the requirement for executives to justify their choices in front of a shareholder reunion also reduces excessive risk taking, and appears to be even more effective than long-term stock-ownership plans. A combination of long-term stock-ownership plans and increased accountability thus seem a promising direction for reining in excessive risk taking by executives.

Keywords: executive compensation, stock-options, incentives, accountability, risk taking

JEL Classification: D03, G28, G32, J33, L22

Suggested Citation

Lefebvre, Mathieu and Vieider, Ferdinand M., Reining in Excessive Risk Taking by Executives: Experimental Evidence (March 1, 2010). GATE Working Paper No. 1006, Available at SSRN: https://ssrn.com/abstract=1573640 or http://dx.doi.org/10.2139/ssrn.1573640

Mathieu Lefebvre (Contact Author)

University of Liege - Research Center on Public and Population Economics ( email )

B-4000 Liege
Belgium

Ferdinand M. Vieider

University of Lyon, CNRS-GATE ( email )

93, chemin des Mouilles
Ecully, 69130
France

German Institute for Economic Research (DIW Berlin)

Mohrenstraße 58
Berlin, 10117
Germany

WZB Berlin Social Science Center ( email )

Reichpietschufer 50
D-10785 Berlin, 10785
Germany

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