Managerial Hedging and Portfolio Monitoring

49 Pages Posted: 27 Feb 2005  

Adriano A. Rampini

Duke University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Alberto Bisin

New York University (NYU) - Department of Economics; New York University (NYU) - Center for Experimental Social Science (CESS); National Bureau of Economic Research (NBER)

Piero Gottardi

European University Institute - Department of Economics; Ca Foscari University of Venice - Dipartimento di Economia; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: November 2004

Abstract

Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his incentive compensation using financial markets and shareholders can only imperfectly monitor the manager's portfolio in order to keep him from hedging the risk in his compensation. We find that the optimal contract implies incentive compensation and governance provisions with the following properties: (i) the manager's portfolio is monitored only when the firm performs poorly, (ii) the manager's compensation is more sensitive to firm performance when monitoring is more costly or when hedging markets are more developed, and (iii) conditional on the firm's performance, the manager's compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring.

Keywords: Executive Compensation, Incentives, Monitoring, Corporate Governance

JEL Classification: G30, D82

Suggested Citation

Rampini, Adriano A. and Bisin, Alberto and Gottardi, Piero, Managerial Hedging and Portfolio Monitoring (November 2004). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=665323 or http://dx.doi.org/10.2139/ssrn.665323

Adriano A. Rampini (Contact Author)

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708
United States
+1 919 660-7797 (Phone)
+1 919 660-8038 (Fax)

HOME PAGE: http://faculty.fuqua.duke.edu/~rampini/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Alberto Bisin

New York University (NYU) - Department of Economics

14 West 4th Street
New York, NY 10012
United States

New York University (NYU) - Center for Experimental Social Science (CESS) ( email )

One Washington Place
New York, NY 10003
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Piero Gottardi

European University Institute - Department of Economics ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy
+39 041 257 4192 (Phone)
+39 041 257 4176 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Paper statistics

Downloads
82
Rank
154,577
Abstract Views
1,484