On the Trade-Off between Risk and Compensation

Journal of Theoretical Accounting Research, Forthcoming

Posted: 3 Oct 2012 Last revised: 29 Jul 2014

Paolo Petacchi

Georgetown University - Robert Emmett McDonough School of Business

Date Written: July 3, 2012

Abstract

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

Suggested Citation

Petacchi, Paolo, On the Trade-Off between Risk and Compensation (July 3, 2012). Journal of Theoretical Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2155737

Paolo Petacchi (Contact Author)

Georgetown University - Robert Emmett McDonough School of Business ( email )

37th and O Streets, NW
Washington, DC 20057
United States

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