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An Experimental Analysis of Risk Shifting Behavior

Review of Corporate Finance Studies, Forthcoming

47 Pages Posted: 13 Jul 2014 Last revised: 4 Aug 2016

Pablo Hernandez-Lagos

New York University, Abu Dhabi

Paul Povel

University of Houston - Department of Finance, C.T. Bauer College of Business

Giorgo Sertsios

Universidad de los Andes, Chile

Date Written: July 29, 2016

Abstract

We study risk-shifting behavior in a laboratory experiment, a setup that overcomes methodological hurdles faced by empiricists in the past. The participants are high-level managers. We observe risk shifting in a simple setup, but less in a setup with a continuation value. Reputation effects also reduce risk shifting. When combined, a continuation value and reputation effects eliminate risk shifting. Our findings shed light on environments in which risk-shifting is unlikely to happen, and why earlier studies produced conflicting results. In particular, our findings show that managers’ concerns with their own reputations are an important factor that mitigates risk shifting.

Keywords: Experimental Corporate Finance, Risk Shifting, Asset Substitution

JEL Classification: G31, G32, G33

Suggested Citation

Hernandez-Lagos, Pablo and Povel, Paul and Sertsios, Giorgo, An Experimental Analysis of Risk Shifting Behavior (July 29, 2016). Review of Corporate Finance Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2465389 or http://dx.doi.org/10.2139/ssrn.2465389

Pablo Hernandez-Lagos

New York University, Abu Dhabi ( email )

PO Box 903
NYC, NY 10276-0903
United States

HOME PAGE: http://pablohernandez-lagos.com

Paul Povel (Contact Author)

University of Houston - Department of Finance, C.T. Bauer College of Business ( email )

University of Houston
334 Melcher Hall
Houston, TX 77204
United States
713-743-4759 (Phone)

HOME PAGE: http://www.bauer.uh.edu/povel

Giorgo Sertsios

Universidad de los Andes, Chile ( email )

Mons. Álvaro del Portillo
Las Condes
Santiago, 12.455
Chile

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