Dynamic Risk Taking with Bonus Schemes

35 Pages Posted: 5 Feb 2011 Last revised: 12 May 2014

See all articles by Dietmar Leisen

Dietmar Leisen

Johannes Gutenberg University Mainz - Department of Banking

Date Written: May 12, 2014

Abstract

This paper studies dynamic risk taking by a risk-averse manager who receives a bonus; the company may default on its contractual obligations (debt, fixed compensation). We show that risk-taking is time-independent, and is summarized by the so-called risk-aversion of derived utility. We highlight the importance of dynamic aspects and provide a foundation for common qualitative discussions that are based on characteristics of bonus functions. The paper cautions that deferral of fixed compensation may increase risk taking. Finally, we motivate a new bonus scheme that incentivizes the manager to implement the socially optimal risk level.

Keywords: Bonus, Risk, Incentives, Options

JEL Classification: G11, G13, G32

Suggested Citation

Leisen, Dietmar P. J., Dynamic Risk Taking with Bonus Schemes (May 12, 2014). Available at SSRN: https://ssrn.com/abstract=1755093 or http://dx.doi.org/10.2139/ssrn.1755093

Dietmar P. J. Leisen (Contact Author)

Johannes Gutenberg University Mainz - Department of Banking ( email )

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