Managerial Incentives to Take Asset Risk
Forthcoming, Journal of Corporate Finance
67 Pages Posted: 25 Apr 2010 Last revised: 20 Oct 2020
Date Written: October 16, 2020
We argue that incentives to take equity risk ("equity incentives") only partially capture incentives to take asset risk ("asset incentives"). This is because leverage, while central to the theory of risk shifting, is not explicitly considered by equity incentives. Employing measures of asset incentives that account for leverage, we find that asset risk-taking incentives can be large compared to incentives to increase firm value. Stock holdings can induce substantial risk-taking incentives, contrary to the assumption that only stock options drive risk-taking. Finally, asset incentives help explain asset risk-taking of U.S. financial institutions before the 2007/08 crisis.
Keywords: Asset risk-taking; compound options; executive compensation; financial crisis; managerial incentives; risk-shifting; write-downs
JEL Classification: G01, G28, G34
Suggested Citation: Suggested Citation