CEO Contract Design Regulation and Risk-Taking
55 Pages Posted: 10 Nov 2015
Date Written: April 30, 2015
Since 2009, the European Commission requires firms to incorporate an array of new elements into CEO compensation contracts, such as bonus caps, claw back provisions, bonus deferral, performance-vesting, and minimum shareholding guidelines. This paper examines whether CEO contract design in line with the EC principles reduces risk-taking and its economic consequences. Using hand-collected contract design data of 763 firm-years from European listed non-financial firms, we construct an index that reflects a firm's contract fit with the EC principles. Complemented by hand-collected data of national regulatory changes consistent to the EC principles, we employ the regime shift as quasi-experiment. We find that CEOs rewarded under contracts more in line with the principles choose lower risk profiles with respect to their country peers by divergent reductions of idiosyncratic and systematic risk-taking. Moreover, intensity of change of the regulatory environment negatively affects systematic risk-taking. However, reduced risk-taking might lead to reduced subsequent performance.
Keywords: Management compensation; CEO contract design; Risk-taking; Institutional differences
JEL Classification: G32, G34, J33, M52
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