Executive Pay, Innovation, and Risk‐Taking

31 Pages Posted: 6 May 2015

See all articles by Volker Laux

Volker Laux

University of Texas at Austin - McCombs School of Business

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Date Written: Summer 2015

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.

Suggested Citation

Laux, Volker, Executive Pay, Innovation, and Risk‐Taking (Summer 2015). Journal of Economics & Management Strategy, Vol. 24, Issue 2, pp. 275-305, 2015, Available at SSRN: https://ssrn.com/abstract=2602987 or http://dx.doi.org/10.1111/jems.12090

Volker Laux (Contact Author)

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

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