Managerial Performance Incentives and Firm Risk during Economic Expansions and Recessions
83 Pages Posted: 12 Aug 2014 Last revised: 22 Jun 2015
Date Written: August 6, 2014
Abstract
We argue that the relationship between managerial pay-for-performance incentives and risk taking is procyclical. We study the relationship between incentives provided by stock-based compensation and firm risk for U.S. non-financial corporations over the two business cycles between 1992 and 2009. We show that a given level of pay-for-performance incentives results in significantly lower firm risk when the economy is in a downturn. The documented procyclical relationship between incentives and risk taking is consistent with state-dependent risk aversion. Our findings contribute to the literature on the depressive effects of performance incentives on firm risk by documenting the importance of the interaction between performance incentives and risk aversion.
Keywords: executive compensation, risk taking, equity-based compensation, macroeconomy
JEL Classification: G3, M52
Suggested Citation: Suggested Citation