On the Trade-Off between Risk and Compensation
Georgetown University - Robert Emmett McDonough School of Business
July 3, 2012
Journal of Theoretical Accounting Research, Forthcoming
In a principal agent setting I show that the trade-off between risk and compensation is not monotonic. It is always beneficial for a company to offer a pay-per-performance contract that entails an additional performance measure that imposes more risk to the agent. The agent benefits from the imposition only if he is sufficiently risk averse and/or the additional performance measure is risky enough. The paper sheds light on the mixed results on the association between risk and incentives, and also offers some insight on organizational policies on incentives and communication.
Keywords: Incentives, risk, uncertainty, standard agency model
JEL Classification: J33, J41, G32, L22
Date posted: October 3, 2012 ; Last revised: July 29, 2014