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Risk taking of executives under different incentive contracts: experimental evidence

Lefebvre, M. and Vieider, F. M. (2014) Risk taking of executives under different incentive contracts: experimental evidence. Journal of Economic Behavior & Organization, 97. pp. 27-36. ISSN 0167-2681

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To link to this item DOI: 10.1016/j.jebo.2013.10.008

Abstract/Summary

Classic financial agency theory recommends compensation through stock options rather than shares to counteract excessive risk aversion in agents. In a setting where any kind of risk taking is suboptimal for shareholders, we show that excessive risk taking may occur for one of two reasons: risk preferences or incentives. Even when compensated through restricted company stock, experimental CEOs take large amounts of excessive risk. This contradicts classical financial theory, but can be explained through risk preferences that are not uniform over the probability and outcome spaces, and in particular, risk seeking for small probability gains and large probability losses. Compensation through options further increases risk taking as expected. We show that this effect is driven mainly by the personal asset position of the experimental CEO, thus having deleterious effects on company performance.

Item Type:Article
Refereed:Yes
Divisions:Faculty of Arts, Humanities and Social Science > School of Politics, Economics and International Relations > Economics
ID Code:54867
Uncontrolled Keywords:Executive compensation, Experimental finance, prospect theory, risk preferences
Publisher:Elsevier

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