CEO Compensation and Corporate Risk: Evidence from a Natural Experiment

By Todd A. Gormley, David A. Matsa, Todd Milbourn. 2013

313 citations recorded by the source corpus.

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.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/000a3d805b0cefea08112101e04baafcb51f3d83

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Citations in the corpus

Stock Options and Managerial Incentives for Risk-Taking: Evidence from FAS 123R (2012, unknown): “As noted in Guay (1999), the incentives that options provide for increasing risk are positively related to the convexity of the option payoff, but they are negatively related to the risk premium required by the manager to hold the options.”
SG&A cost stickiness and equity-based executive compensation: does empire building matter? (2014, background): “Another reason against the expectation of aligning interests of the manager and shareholders is that a manager with equity incentives faces bounded losses so that risk-seeking might be higher than the risk in the interest of the firm (Gormley et al. 2013).”
Playing It Safe? Managerial Preferences, Risk, and Agency Conflicts (2016, background): “In this case, increasing the convexity of the manager’s payoff structure would be more appropriate (see Guay, 1999; Gormley, Matsa, and Milbourn 2013; and many others).”
ESG Shareholder Engagement and Downside Risk (2018, background): “Further, evidence shows that increased tail risk can have consequences for corporate investment and risk-taking (Gormley and Matsa, 2011; Gormley, Matsa, and Milbourn, 2013).”
The causal effect of option pay on corporate risk management (2016, unknown): “While Chava and Purnanandam (2010) and Gormley, Matsa, and Milbourn (2013) find a positive relationship between option pay and corporate risk-taking behavior, Hayes, Lemmon and Qiu (2012) fail to find such a relationship.”
Sharing Risk with the Government: How Taxes Affect Corporate Risk Taking (2017, unknown): “…2016), the sensitivity of CEO wealth to stock volatility (Coles, Daniel, and Naveen 2006), stock option compensation (Rajgopal and Shevlin 2002; Gormley, Matsa, and Milbourn 2013), inside debt (Cassell, Huang, Manuel Sanchez, and Stuart 2012; Choy, Lin, and Officer 2014), corporate governance…”