Labor Unemployment Risk and CEO Incentive Compensation

58 Pages Posted: 22 Nov 2016

See all articles by Andrew Ellul

Andrew Ellul

Indiana University - Kelley School of Business - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); University of Naples Federico II - CSEF - Center for Studies in Economics and Finance

Cong Wang

The Chinese University of Hong Kong, Shenzhen

Kuo Zhang

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management

Multiple version iconThere are 2 versions of this paper

Date Written: November 2016

Abstract

We investigate the impact of workers' exposure to unemployment risk on the design of CEO incentive compensation. Through its impact on risk-taking activities, option-based compensation is likely to also influence unemployment risk which is internalized by the firm. Exploiting state-level changes in unemployment benefits as a source of variation in workers' unemployment costs, we find that after unemployment insurance benefits become more generous boards increase the CEOs' convex payoff structure. This behavior is consistent with the view that CEO's risk-taking incentives are amplified by the board to take advantage of lower costs associated with unemployment risk. The increase in convexity payoff structures is stronger when CEO wealth is tied closely to firm performance, more pronounced in labor-intensive industries, and attenuated by the strength of unionization. Changes in the incentive structures are associated with riskier investment and financing strategies and better performance. Results suggest that executive compensation is one mechanism used by boards to internalize labor market frictions in firms' decisions.

Keywords: Executive compensation, Human Capital, leverage, Risk Taking, unemployment risk

JEL Classification: G32, G34

Suggested Citation

Ellul, Andrew and Wang, Cong and Zhang, Kuo, Labor Unemployment Risk and CEO Incentive Compensation (November 2016). CEPR Discussion Paper No. DP11634. Available at SSRN: https://ssrn.com/abstract=2873531

Andrew Ellul (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

University of Naples Federico II - CSEF - Center for Studies in Economics and Finance ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Cong Wang

The Chinese University of Hong Kong, Shenzhen ( email )

Kuo Zhang

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management

1954 Huashan Road
Shanghai Jiao Tong University
Shanghai, Shanghai 200030
China

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