Uncertainty, Risk, and Incentives: Theory and Evidence

39 Pages Posted: 9 Apr 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 Board - Capital Markets Section

Jianfeng Yu

Tsinghua University - PBC School of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: February 21, 2013

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 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 trade-off, 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: D86, J33

Suggested Citation

He, Zhiguo and Li, Si and Wei, Bin and Yu, Jianfeng, Uncertainty, Risk, and Incentives: Theory and Evidence (February 21, 2013). FEDS Working Paper No. 2013-18. Available at SSRN: https://ssrn.com/abstract=2246914 or http://dx.doi.org/10.2139/ssrn.2246914

Zhiguo He

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 (Contact Author)

Federal Reserve Board - Capital Markets Section ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Jianfeng Yu

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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