Executive Pay, Innovation, and Risk-Taking

Journal of Economics and Management Strategy, Forthcoming

Posted: 9 Mar 2014

See all articles by Volker Laux

Volker Laux

University of Texas at Austin - McCombs School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: March 7, 2014

Abstract

This paper analyzes the optimal equity pay mix in a setting in which executives face career concerns and must be motivated to search for innovative investment ideas and to make appropriate decisions regarding whether to pursue the uncovered idea. I show that, depending on the value of the firm's potential growth opportunities and the CEO's concern about being fired, the CEO is either tempted to overinvest in risky ideas (excessive risk-taking) or underinvest in risky ideas (excessive conservatism). The optimal pay package consists of stock options, to encourage the discovery of innovative ideas, and either restricted stock, to combat excessive risk-taking, or severance pay, to combat excessive conservatism. The model provides new empirical predictions relating executive pay arrangements to the importance of innovation and career concerns and analyzes how the change in the economic environment caused by the current financial crisis might change the optimal mix of stock options, restricted stock, and severance pay.

Keywords: Executive Pay, Stock Options, Restricted Stock, Severance Pay

JEL Classification: J33, G24

Suggested Citation

Laux, Volker, Executive Pay, Innovation, and Risk-Taking (March 7, 2014). Journal of Economics and Management Strategy, Forthcoming , Available at SSRN: https://ssrn.com/abstract=2406222

Volker Laux (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

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Austin, TX 78712
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