Asymmetry of CEO Compensation and the Role of Relative and Macroeconomic Shocks in Risk Taking Incentives

49 Pages Posted: 7 Oct 2015

See all articles by Hsin-Hui Chiu

Hsin-Hui Chiu

California State University, Northridge

Lars Oxelheim

Research Institute of Industrial Economics (IFN); University of Agder; Knut Wicksell Center for Financial Studies, Lund University

Clas Wihlborg

Chapman University; University West

Jianhua Zhang

Göteborg University - School of Business, Economics and Law

Date Written: September 15, 2015

Abstract

If managers are risk-averse and compensation schemes are not directly linked to shareholder wealth, incentives to allocate effort to manage effects of relative and macroeconomic shocks may be distorted. In this paper we develop a simple model to identify factors that determine the optimal allocation of effort to manage relative and macroeconomic shocks. We then show how serial correlation in shocks, the relative variance of shocks and the ability of managers to influence the effects of shocks on shareholder wealth determine the optimal allocation of managerial effort. Thereafter, we emphasize how CEO compensation depends on performance variables distinguishing between relative and macroeconomic sources of changes in compensation. In our empirical analysis on the asymmetry of compensation in response to relative and macroeconomic shocks we use CEO’s firm-related wealth in a sample of U.S. CEOs during 1993-2012. The empirical results show that macroeconomic fluctuations explain a large part of the variances of compensation and firm-related wealth. We find only weak evidence of asymmetric incentives in these two variables. Thus, if managers are risk-averse, their incentives to reduce the impact of macroeconomic fluctuations are strong and possibly excessive. We conclude that the role of macroeconomic fluctuations and the ability of the CEO to adjust operations in response to these fluctuations should be considered simultaneously when designing individual CEO compensation incentive schemes.

Keywords: Macroeconomic Fluctuations, Luck, Performance, CEO Compensation, Asymmetry, Risk Incentives

JEL Classification: G30, G32, J33, E00, L14, L16, M21, M52

Suggested Citation

Chiu, Hsin-Hui and Oxelheim, Lars and Wihlborg, Clas and Zhang, Jianhua, Asymmetry of CEO Compensation and the Role of Relative and Macroeconomic Shocks in Risk Taking Incentives (September 15, 2015). Available at SSRN: https://ssrn.com/abstract=2669998 or http://dx.doi.org/10.2139/ssrn.2669998

Hsin-Hui Chiu

California State University, Northridge ( email )

18111 Nordoff Street
Northridge, CA 91330
United States

Lars Oxelheim (Contact Author)

Research Institute of Industrial Economics (IFN) ( email )

P.O. Box 55665
SE-10215 Stockholm
Sweden
+46 8 665 4527 (Phone)
+46 8 665 4599 (Fax)

University of Agder ( email )

Serviceboks 422
N-4604 Kristiansand, VEST AGDER 4604
Norway

Knut Wicksell Center for Financial Studies, Lund University ( email )

P.O.Box 7080
S-220 07 Lund
Sweden
+46462228744 (Phone)

Clas Wihlborg

Chapman University ( email )

333 N. Glassell
Orange, CA 92866
United States
+17147447630 (Phone)

University West ( email )

Trollhättan, 46186
Sweden

Jianhua Zhang

Göteborg University - School of Business, Economics and Law ( email )

Box 640
SE 405 30 Goeteborg
Sweden
+46-(0)31-7732689 (Phone)
+46-(0)31-7734154 (Fax)

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