Risk Choices and Compensation Design

64 Pages Posted: 25 Apr 2015

See all articles by Mark Carey

Mark Carey

Board of Governors of the Federal Reserve - Division of International Finance (IFDP) - International Banking Section

Bo Sun

Board of Governors of the Federal Reserve System - Division of International Finance

Date Written: January 25, 2015

Abstract

We analyze the impact of bad-tail risks on managerial pay functions, especially the decision to pay managers in stock or in options. In contrast to conventional wisdom, we find that options are often a superior vehicle for limiting managerial incentives to take bad-tail risks while providing incentives to exert effort. Arrangements similar to collar options are able to incent the desired project choice in wider range of circumstances than call options or stock. However, information requirements appear high. We briefly explore alternatives with features similar to maluses and clawbacks, which are a bit like weakening the limited liability of managers.

Keywords: Compensation, Bad tail risk

JEL Classification: G34, D86, G20

Suggested Citation

Carey, Mark and Sun, Bo, Risk Choices and Compensation Design (January 25, 2015). FRB International Finance Discussion Paper No. 1130. Available at SSRN: https://ssrn.com/abstract=2598238 or http://dx.doi.org/10.2139/ssrn.2598238

Mark Carey (Contact Author)

Board of Governors of the Federal Reserve - Division of International Finance (IFDP) - International Banking Section ( email )

20th & C Streets NW
Washington, DC 20551
United States
202-452-2784 (Phone)
202-452-5295 (Fax)

Bo Sun

Board of Governors of the Federal Reserve System - Division of International Finance ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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