Time-Series Variation in the Efficacy of Executive Risk-Taking Incentives: The Role of Uncertainty

54 Pages Posted: 1 Dec 2020 Last revised: 2 Mar 2021

See all articles by Brian D. Cadman

Brian D. Cadman

University of Utah - David Eccles School of Business

John L. Campbell

University of Georgia - J.M. Tull School of Accounting

Ryan G. Johnson

University of Georgia - J.M. Tull School of Accounting

Date Written: March 1, 2021

Abstract

Prior research establishes that boards of directors can encourage risk-averse managers to take risky actions by providing stock options and severance pay. We demonstrate that the ability of these incentives to encourage risk-taking hinges on the level of uncertainty facing the manager, and that the level of uncertainty varies across time. We confirm prior findings that stock option convexity encourages risk-taking, but find that this relation only holds when the level of uncertainty is low. We also confirm prior findings that severance pay encourages risk-taking, but find that this relation only holds when the level of uncertainty is high. Finally, we find that compensation committees respond to uncertainty by adjusting the level of option compensation. Overall, our results suggest that the effectiveness of incentives to take risk varies with the level of uncertainty facing the manager, and that boards consider this in annual compensation design.

Keywords: executive compensation, market uncertainty, corporate governance, executive risk-taking incentives

JEL Classification: G30, G34, K22, M40, M46

Suggested Citation

Cadman, Brian D. and Campbell, John L. and Johnson, Ryan G., Time-Series Variation in the Efficacy of Executive Risk-Taking Incentives: The Role of Uncertainty (March 1, 2021). Available at SSRN: https://ssrn.com/abstract=3719591 or http://dx.doi.org/10.2139/ssrn.3719591

Brian D. Cadman (Contact Author)

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

1645 Campus Center Drive
Salt Lake City, UT 84112
United States
801-585-9517 (Phone)

HOME PAGE: http://www.business.utah.edu/bio/briancadman

John L. Campbell

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706.542.3595 (Phone)
706.542.3630 (Fax)

Ryan G. Johnson

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

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