Compensation, Convexity, and the Incentives to Manage Risk PDF Download
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Author: Wayne R. Guay
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
To control risk-related stockholder/manager agency conflicts effectively, equity holders are expected to manage, in addition to the pay-performance slope, the convexity of the relation between firm performance and managers' wealth. I examine the stock-based compensation of 278 corporate CEOs and find stock options play an economically significant role in increasing the convexity of the wealth-performance relation. The magnitude of the convexity provided by common stock is several orders of magnitude lower than that of stock options and of little economic importance for most CEOs in the sample. In cross-sectional tests, after controlling for the slope of the pay-performance relation, convexity is positively related to the proportion of growth options in firms' investment opportunity sets. This is consistent with firms providing managers with incentives to take risky projects when the potential loss from underinvestment in valuable risk projects is greatest. Convexity is also found to be negatively related to financial leverage and positively related to firm size. This result supports extant risk-management theory, and is consistent with firms providing managers with lower risk- taking incentives when the value created from hedging is likely to be greatest.
Author: Wayne R. Guay
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
To control risk-related stockholder/manager agency conflicts effectively, equity holders are expected to manage, in addition to the pay-performance slope, the convexity of the relation between firm performance and managers' wealth. I examine the stock-based compensation of 278 corporate CEOs and find stock options play an economically significant role in increasing the convexity of the wealth-performance relation. The magnitude of the convexity provided by common stock is several orders of magnitude lower than that of stock options and of little economic importance for most CEOs in the sample. In cross-sectional tests, after controlling for the slope of the pay-performance relation, convexity is positively related to the proportion of growth options in firms' investment opportunity sets. This is consistent with firms providing managers with incentives to take risky projects when the potential loss from underinvestment in valuable risk projects is greatest. Convexity is also found to be negatively related to financial leverage and positively related to firm size. This result supports extant risk-management theory, and is consistent with firms providing managers with lower risk- taking incentives when the value created from hedging is likely to be greatest.
Author: Musa Amadeus
Publisher:
ISBN:
Category :
Languages : en
Pages : 55
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Book Description
This paper demonstrates that executive compensation convexity, measured as the sensitivity of managerial equity compensation portfolios to stock volatility, predicts firm-specific crashes. A bottom-to-top decile change in compensation convexity results in a 21% increase in a firm's crash risk after controlling for managerial price-increasing incentives. In contrast, there is no robust evidence of a symmetric relation between compensation convexity and a firm's idiosyncratic positive jump risk. We exploit an exogenous shock to compensation convexity, arising from a change in the expensing treatment of executive stock options, in further supporting our interpretations within a natural experiment setting. Our results suggest that managerial equity compensation portfolios do not augment a firm's future idiosyncratic crash risk because they link managerial wealth to equity prices, but rather because they tie managerial wealth to the volatility of a firm's equity.
Author: Bo Sun
Publisher: DIANE Publishing
ISBN: 1437930980
Category : Business & Economics
Languages : en
Pages : 33
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Book Description
Analyzes executive compensation in a setting where managers may take a costly action to manipulate corporate performance, and whether managers do so is stochastic. Examines how the opportunity to manipulate affects the optimal pay contract, and establishes necessary and sufficient conditions under which earnings management occurs. The author¿s model provides a set of implications on the role earnings management plays in driving the time-series and cross-sectional variation of executive compensation. In addition, the model's predictions regarding the changes of earnings management and executive pay in response to corporate governance legislation are consistent with empirical observations. Charts and tables.
Author: Robert W. Kolb
Publisher: Oxford University Press
ISBN: 0199829586
Category : Business & Economics
Languages : en
Pages : 231
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Book Description
The scholarly literature on executive compensation is vast. As such, this literature provides an unparalleled resource for studying the interaction between the setting of incentives (or the attempted setting of incentives) and the behavior that is actually adduced. From this literature, there are several reasons for believing that one can set incentives in executive compensation with a high rate of success in guiding CEO behavior, and one might expect CEO compensation to be a textbook example of the successful use of incentives. Also, as executive compensation has been studied intensively in the academic literature, we might also expect the success of incentive compensation to be well-documented. Historically, however, this has been very far from the case. In Too Much Is Not Enough, Robert W. Kolb studies the performance of incentives in executive compensation across many dimensions of CEO performance. The book begins with an overview of incentives and unintended consequences. Then it focuses on the theory of incentives as applied to compensation generally, and as applied to executive compensation particularly. Subsequent chapters explore different facets of executive compensation and assess the evidence on how well incentive compensation performs in each arena. The book concludes with a final chapter that provides an overall assessment of the value of incentives in guiding executive behavior. In it, Kolb argues that incentive compensation for executives is so problematic and so prone to error that the social value of giving huge incentive compensation packages is likely to be negative on balance. In focusing on incentives, the book provides a much sought-after resource, for while there are a number of books on executive compensation, none focuses specifically on incentives. Given the recent fervor over executive compensation, this unique but logical perspective will garner much interest. And while the literature being considered and evaluated is technical, the book is written in a non-mathematical way accessible to any college-educated reader.
Author: Dirk Jenter
Publisher:
ISBN:
Category :
Languages : en
Pages : 62
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Book Description
This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private trading decisions in incentive creation. With option-based compensation contracts, the average pay-forperformance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure implies that the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to "indexing" the stock or option grant, making explicit indexation of the contract redundant. Keywords: executive compensation, equity-based compensation, created incentives.
Author: Paul Kupiec
Publisher:
ISBN:
Category :
Languages : en
Pages : 33
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Book Description
In a stylized model of a financial intermediary, risk managers expend costly effort to reduce loan PD and LGD. When effort is unobservable, incentive compensation (IC) can induce manager effort, but underwriting and loss mitigation managers require different IC contracts. Subsidized insured deposit funding decreases the demand for risk management because it decreases the insurance subsidy. When IC is required to induce effort, it further increases the principal's costs because wages which are subsidized by the insurer are replaced with IC which is not. These additional costs reduce the principal's demand for risk management and discourage IC contracts. Regulatory policy should reinforce an insured depository's incentives to offer appropriate risk management IC contracts and yet existing regulatory guidance explicitly discourages performance-linked IC for risk managers.
Author: Ingolf Dittmann
Publisher:
ISBN:
Category :
Languages : en
Pages : 53
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Book Description
Abstract We consider a model in which shareholders provide a risk-averse CEO with risk-taking incentives in addition to effort incentives. We show that the optimal contract protects the CEO from losses for bad outcomes and is convex for medium outcomes and concave for good outcomes. We calibrate the model to data on 1,707 CEOs and show that it explains observed contracts much better than the standard model without risk-taking incentives. When we apply the model to contracts that consist of base salary, stock, and options, the results suggest that options should be issued in the money. Our model also helps us rationalize the universal use of at-the-money options when the tax code is taken into account. Moreover, we propose a new way of measuring risk-taking incentives in which the expected value added to the firm is traded off against the additional risk a CEO has to bear.
Author: Mercer, LLC
Publisher: John Wiley & Sons
ISBN: 047047811X
Category : Business & Economics
Languages : en
Pages : 288
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Book Description
The numerous incentive approaches and combinations and their implications can be dizzying even to the compensation professional. Pay for Results provides a road map for developing and implementing executive incentives that drive business needs and strategy. It is filled with specific analytic tools, including tables, exhibits, forms, checklists. In addition, it uncovers myths in performance measurement strategy and design. Timely and thorough, this book expertly shows businesses how to drive their specific needs and strategy. Human resources and compensation officers will discover how to apply performance metrics that align with shareholder investment.
Author: Benjamin Hermalin
Publisher: Elsevier
ISBN: 0444635408
Category : Business & Economics
Languages : en
Pages : 762
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Book Description
The Handbook of the Economics of Corporate Governance, Volume One, covers all issues important to economists. It is organized around fundamental principles, whereas multidisciplinary books on corporate governance often concentrate on specific topics. Specific topics include Relevant Theory and Methods, Organizational Economic Models as They Pertain to Governance, Managerial Career Concerns, Assessment & Monitoring, and Signal Jamming, The Institutions and Practice of Governance, The Law and Economics of Governance, Takeovers, Buyouts, and the Market for Control, Executive Compensation, Dominant Shareholders, and more. Providing excellent overviews and summaries of extant research, this book presents advanced students in graduate programs with details and perspectives that other books overlook. Concentrates on underlying principles that change little, even as the empirical literature moves on Helps readers see corporate governance systems as interrelated or even intertwined external (country-level) and internal (firm-level) forces Reviews the methodological tools of the field (theory and empirical), the most relevant models, and the field’s substantive findings, all of which help point the way forward
Author: Andrew Ellul
Publisher:
ISBN:
Category : Chief executive officers
Languages : en
Pages : 54
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Book Description
We investigate the impact of workers' exposure to unemployment risk on the design of CEO incentive compensation. Through its impact on risk-taking activities, option-based compensation is likely to also influence unemployment risk which is internalized by the firm. Exploiting state-level changes in unemployment benefits as a source of variation in workers' unemployment costs, we find that after unemployment insurance benefits become more generous boards increase the CEOs' convex payoff structure. This behavior is consistent with the view that CEO's risk-taking incentives are amplified by the board to take advantage of lower costs associated with unemployment risk. The increase in convexity payoff structures is stronger when CEO wealth is tied closely to firm performance, more pronounced in labor-intensive industries, and attenuated by the strength of unionization. Changes in the incentive structures are associated with riskier investment and financing strategies and better performance. Results suggest that executive compensation is one mechanism used by boards to internalize labor market frictions in firms' decisions.
