Yesterday's Heroes: Compensation and Creative Risk-Taking

Yesterday's Heroes: Compensation and Creative Risk-Taking

Ing-Haw Cheng, Harrison Hong, José Scheinkman

Series number :

Serial Number: 
285/2010

Date posted :

June 01 2010

Last revised :

June 16 2010
SSRN Share

Keywords

  • financial crisis • 
  • executive compensation

Many believe that compensation, misaligned from shareholders’ value due to managerial entrenchment, caused financial firms to take creative risks before the Financial Crisis of 2008.

We argue instead that even in a classical principal-agent setting without entrenchment and with exogenous firm-risk, riskier firms may offer higher total pay as compensation for the extra risk in equity stakes born by risk-averse managers. We confirm our conjecture by using lagged stock return volatility to measure exogenous firm risk and showing that riskier firms are also more productive and are more likely to be held by institutional investors, who are most able to influence compensation.

Authors

Real name: 
Ing-Haw Cheng
Real name: 
Harrison Hong
Real name: 
José Scheinkman