Optimal Managerial Hedging and Contracting with Self-Esteem Concerns

Posted: 9 Apr 2013 Last revised: 4 Jan 2015

See all articles by Chongwoo Choe

Chongwoo Choe

Monash University - Department of Economics

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Chia-Feng (Jeffrey) Yu

University of Adelaide - Business School; Financial Research Network (FIRN)

Date Written: January 4, 2015

Abstract

Motivated by psychological evidence that self-esteem plays an important role in individual decision-making, this paper studies how self-esteem concerns influence a manager's effort choice and hedging behavior and how a board designs the managerial compensation in response. We show that when the manager has stronger self-esteem concerns, it requires higher managerial ownership to induce effort. In equilibrium, the manager's net hedging position increases with the strength of the manager's self-esteem concerns. Each of managerial hedging and self-esteem concerns added to an otherwise standard agency model increases the equilibrium pay-performance sensitivity. The agency cost increases as the manager's self-esteem concerns become stronger, but the manager's access to hedging opportunities itself does not change the agency cost. We also discuss how our basic model can be extended to account for circumstances under which managerial hedging can affect firm value.

Keywords: Managerial Hedging, Executive Compensation, Self-Esteem, Agency Cost

JEL Classification: D86, G02, G32

Suggested Citation

Choe, Chongwoo and Lien, Donald and Yu, Chia-Feng (Jeffrey), Optimal Managerial Hedging and Contracting with Self-Esteem Concerns (January 4, 2015). International Review of Economics & Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2246335 or http://dx.doi.org/10.2139/ssrn.2246335

Chongwoo Choe

Monash University - Department of Economics ( email )

Department of Economics
PO Box 197
Caulfield East, Victoria 3145
Australia
+61 2 9903 1125 (Phone)
+61 2 9903 1128 (Fax)

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Chia-Feng (Jeffrey) Yu (Contact Author)

University of Adelaide - Business School ( email )

10 Pulteney Street
Adelaide, SA 5005
Australia
+61-08-83132073 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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