Outside Opportunities, Managerial Risk Preferences, and CEO Compensation

Posted: 28 Nov 2017 Last revised: 7 Oct 2019

See all articles by Wen Chen

Wen Chen

City University of Hong Kong (CityUHK)

Sumi Jung

The Chinese University of Hong Kong (CUHK)

Xiaoxia Peng

University of Utah - David Eccles School of Business

Ivy Zhang

University of California, Riverside

Date Written: October 23, 2018

Abstract

Exploiting the setting of staggered adoption of the Inevitable Disclosure Doctrine (hereafter IDD) in U.S. state courts, we examine how quasi-exogenous restrictions of outside employment opportunities affect CEOs’ risk preferences. IDD adoption constrains executives’ ability to work for competitors, resulting in a reduction in their employment options. We expect IDD adoption to increase CEOs’ risk avoidance by increasing their costs of termination and reducing the reward to risk taking. Consistent with this prediction, we find that, when making investment decisions, CEOs are less responsive, post IDD adoption, to risk-inducing incentives provided by their compensation package. The effect is more pronounced for CEOs with more outside opportunities absent the IDD, whom the IDD’s restrictions are more likely to bind. Additional analyses suggest that the board adjusts compensation to overcome the reduction in risk appetite. Overall, we provide new evidence on how external labor market frictions affects CEO risk preferences and compensation.

Keywords: Managerial risk aversion, External labor market, Risk taking, IDD

JEL Classification: G32, M12, J60

Suggested Citation

Chen, Wen and Jung, Sumi and Peng, Xiaoxia and Zhang, Ivy, Outside Opportunities, Managerial Risk Preferences, and CEO Compensation (October 23, 2018). Available at SSRN: https://ssrn.com/abstract=3076044

Wen Chen

City University of Hong Kong (CityUHK) ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Sumi Jung

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Xiaoxia Peng (Contact Author)

University of Utah - David Eccles School of Business ( email )

1655 E Campus Center Dr
Salt Lake City, UT 84112
United States

HOME PAGE: http://www.xiaoxiapeng.com

Ivy Zhang

University of California, Riverside ( email )

900 University Ave
Riverside, CA 92521
United States

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