Risk Management Transparency and Compensation
54 Pages Posted: 25 Jul 2014 Last revised: 17 May 2019
Date Written: May 15, 2019
We examine the design of managerial compensation in a setting in which a manager must be induced to maximize shareholder value while managing the firm's cash flow risks. Our model shows that, while high-powered incentive pay (e.g., options) induces the manager to increase shareholder value, it also provides incentives to engage in unproductive risk-seeking activities. This trade-off suggests that transparent disclosures of risk management practices allow shareholders to provide more powerful incentives to the manager. We empirically test this prediction using the issuance of Statement of Financial Accounting Standards No. 133, which improves information disclosure of firm's use of derivatives.
Keywords: managerial compensation, risk management, corporate hedging, financial officers, FAS 133
JEL Classification: J33, M12, G34
Suggested Citation: Suggested Citation