CEO Compensation and Corporate Risk: Evidence from a Natural Experiment
57 Pages Posted: 2 Dec 2010 Last revised: 17 Jun 2014
Date Written: August 19, 2013
This paper examines the two-way relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms’ business risks. The natural experiment provides an opportunity to examine two classic questions related to incentives and risk — how boards adjust incentives in response to firms’ risk and how these incentives affect managers’ risk-taking. We find that, after left-tail risk increases, boards reduce managers’ exposure to stock price movements and that less convexity from options-based pay leads to greater risk-reducing activities. Specifically, managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.
Keywords: legal liability, regulatory risk, tail risk, stock options, compensation, managerial incentives
JEL Classification: J33, G32, G34, K13
Suggested Citation: Suggested Citation