Interest Rates and Managerial Risk Incentives: The Role of Institutional Investors. Evidence From the US

Abstract

This paper contributes to the literature by indicating how the effect of monetary policies, such as interest rates, the zero lower bound (ZLB) and differential volatility between long-term and short-term interest rates, impact the incentives of firms’ managers in the US in recent years and how the monitoring of institutional ownership influences these relations. Specifically, based on the agency problem between managers and creditors, a research framework is developed that incorporates different macroeconomic conditions to identify their influence on managers’ risk incentives. More than 11,000 industrial firms in US between 1994 and 2012 were examined, and the results indicate that certain macroeconomic conditions, such as low loan interest rates, the ZLB and monetary market stability, increase the managers’ risk incentives, proxied by the sensitivity of stock return volatility. Furthermore, we observe that low interest rates influence the managers’ incentives to intensify risk taking when firms have a higher proportion of “passive” institutional shareholders.

Keywords: Executive Compensation, Monetary Policies, Interest Rates, Managers’ Risk Incentives, Institutional Investors, ZLB Policy

JEL Classification: E41, E43, E51, M12, M52