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Idiosyncratic Risk and the Manager

58 Pages Posted: 22 Mar 2012 Last revised: 12 Aug 2017

Brent Glover

Carnegie Mellon University - David A. Tepper School of Business

Oliver Levine

University of Wisconsin - Madison

Date Written: July 5, 2017

Abstract

We develop a model to characterize and quantify the effects of stock, option, and fixed compensation on a manager's risk-taking incentive and investment choice. We find the average chief executive officer's (CEO) compensation contract incentivizes overinvestment by 1.3 percentage points per year, with significant variation across firms and over time. We estimate a value of CEO effort implied by compensation contracts and find it to be strongly related to firm intangibility. Finally, we assess the effects on investment of FAS 123R and a hypothetical ban on option grants and find heterogeneous responses that depend on firm volatility and the prior structure of compensation.

Keywords: Corporate investment; Executive compensation; Managerial incentives; Agency conflicts; Risk taking

JEL Classification: G31, G32

Suggested Citation

Glover, Brent and Levine, Oliver, Idiosyncratic Risk and the Manager (July 5, 2017). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2024384 or http://dx.doi.org/10.2139/ssrn.2024384

Brent Glover (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Oliver Levine

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States

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