Managerial Incentives and Risk-Taking

Posted: 1 Mar 2005

See all articles by Naveen D. Daniel

Naveen D. Daniel

Drexel University - Department of Finance

Jeffrey L. Coles

University of Utah - Department of Finance

Lalitha Naveen

Temple University - Department of Finance

Abstract

This paper provides empirical evidence of a strong causal relation between the structure of managerial compensation and investment policy, debt policy, and firm risk. Controlling for CEO pay-performance sensitivity (delta) and the feedback effects of firm policy and risk on the structure of the managerial compensation scheme, we find that higher sensitivity of CEO wealth to stock volatility (vega) implements riskier policy choices, including relatively more investment in R&D, less investment in property, plant and equipment, more focus on fewer lines of business, and higher leverage. At the same time, we find that riskier policy choices in general lead to compensation structure with higher vega and lower delta. Stock-return volatility, however, has a positive effect on both vega and delta.

Keywords: executive compensation, managerial incentives, risk-taking, investment policy, debt policy

JEL Classification: G31, G32, G34, J33

Suggested Citation

Daniel, Naveen D. and Coles, Jeffrey L. and Naveen, Lalitha, Managerial Incentives and Risk-Taking. Available at SSRN: https://ssrn.com/abstract=675283

Naveen D. Daniel

Drexel University - Department of Finance ( email )

LeBow College of Business
Philadelphia, PA 19104
United States
215-895-5858 (Phone)
215-895-2955 (Fax)

HOME PAGE: http://lebow.drexel.edu/Faculty/DanielN

Jeffrey L. Coles

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-587-9093 (Phone)

Lalitha Naveen (Contact Author)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-6435 (Phone)

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