Managerial Incentives to Take Asset Risk
60 Pages Posted: 25 Apr 2010 Last revised: 23 Jan 2019
Date Written: January 19, 2019
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. Moreover, stock holdings can induce substantial risk-taking incentives, qualifying common beliefs regarding the central role of stock options.Finally, asset incentives help explain asset risk-taking of U.S. financial institutions before the 2007/08 crisis.
Keywords: Executive compensation, managerial incentives, risk-shifting, asset risk-taking, compound options, financial crisis, write-downs
JEL Classification: G01, G28, G34
Suggested Citation: Suggested Citation