Uncertainty, Risk, and Incentives: Theory and Evidence

38 Pages Posted: 17 Mar 2012 Last revised: 24 Feb 2013

See all articles by Zhiguo He

Zhiguo He

University of Chicago - Finance

Si Li

Wilfrid Laurier University - School of Business & Economics

Bin Wei

Federal Reserve Bank of Atlanta

Jianfeng Yu

Tsinghua University - PBC School of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: January 15, 2012

Abstract

Uncertainty has qualitatively different implications than risk in studying executive incentives. We study the interplay between profitability uncertainty and moral hazard, where profitability is multiplicative with the managerial effort. Investors who face greater uncertainty desire faster learning, and consequently offer higher managerial incentives to induce higher effort from the manager. In contrast to the standard negative risk-incentive tradeoff, this 'learning-by-doing' effect generates a positive relation between profitability uncertainty and incentives. We document empirical support for this prediction.

Keywords: executive compensation, optimal contracting, learning, uncertainty, risk-incentive trade-off

JEL Classification: G30, G34, J33

Suggested Citation

He, Zhiguo and Li, Si and Wei, Bin and Yu, Jianfeng, Uncertainty, Risk, and Incentives: Theory and Evidence (January 15, 2012). Available at SSRN: https://ssrn.com/abstract=2023797 or http://dx.doi.org/10.2139/ssrn.2023797

Zhiguo He (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://www.zhiguohe.com

Si Li

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada

Bin Wei

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

HOME PAGE: http://https://www.frbatlanta.org/research/economists/wei-bin.aspx

Jianfeng Yu

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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