CEO Compensation and Corporate Risk: Evidence from a Natural Experiment

Authors

Todd A. Gormley, Washington University in St. Louis; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)Follow
David A. Matsa, Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER)Follow
Todd T. Milbourn, Southern Methodist University (SMU) - SMU Cox School of BusinessFollow

Publication Date

8-19-2013

Abstract

This paper examines the two-way relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms’ business risks. The natural experiment provides an opportunity to examine two classic questions related to incentives and risk — how boards adjust incentives in response to firms’ risk and how these incentives affect managers’ risk-taking. We find that, after left-tail risk increases, boards reduce managers’ exposure to stock price movements and that less convexity from options-based pay leads to greater risk-reducing activities. Specifically, managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.

Document Type

Article

Keywords

legal liability, regulatory risk, tail risk, stock options, compensation, managerial incentives

Disciplines

Finance

DOI

10.2139/ssrn.1718125

Source

SMU Cox: Finance (Topic)

Language

English