Managerial Risk Aversion and the Structure of Executive Compensation

Abstract

We examine how chief executive officers' (CEOs) innate risk aversion influences the size and structure of their compensation contracts. In so doing, we estimate managerial risk aversion based on the Big Five personality traits—openness, conscientiousness, extraversion, agreeableness, and neuroticism—inferred using IBM's Personality Insights service. We provide evidence that executives' inherent risk aversion is related to their compensation structure. Contrary to agency theory predictions, we find that more risk-averse CEOs receive more cash-based and less equity-based compensation but receive lower total compensation. This relationship is moderated by differences in firms' resource advantages. Despite the theoretical prediction that managerial risk aversion is a key factor determining the structure of executives' compensation contracts, there is limited empirical evidence on whether firms adjust the components of compensation based on CEOs' risk preferences. Our results help us better understand the interplay between CEO personality and executive compensation. This study offers important implications for organizations in that knowledge about executives' inherent risk aversion is important and relevant for designing effective compensation contracts.

Keywords: Corporate Governance, CEO Personality, Risk Aversion, Executive Compensation, Incentive Pay

JEL Classification: J33, G34