[en] 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.
Disciplines :
Economic systems & public economics
Author, co-author :
Lefebvre, Mathieu ; Université de Liège - ULiège > HEC-Ecole de gestion : UER > Economie politique et finances publiques
Vieider, Ferdinand
Language :
English
Title :
Risk Taking of Executives under Different Incentive Contracts: Experimental Evidence
scite shows how a scientific paper has been cited by providing the context of the citation, a classification describing whether it supports, mentions, or contrasts the cited claim, and a label indicating in which section the citation was made.
Bibliography
Abdellaoui M. Parameter-free elicitation of utility and probability weighting functions. Management Science 2000, 46(1):1497-1512.
Abdellaoui M., Bleichrodt H., L'Haridon O. A tractable method to measure utility and loss aversion under prospect theory. Journal of Risk and Uncertainty 2008, 36:245-266.
Abdellaoui M., Baillon A., Placido L., Wakker P.P. The rich domain of uncertainty: source functions and their experimental implementation. American Economic Review 2011, 101:695-723.
Abdellaoui M., Bleichrodt H., Kammoun H. Do financial professionals behave according to prospect theory? An experimental study. Theory and Decision 2013, 74:411-429.
Agrawal A., Mandelker G.M. Managerial incentives and corporate investment and financing decisions. Journal of Finance 1987, 42(4):823-837.
Ai C., Norton E.D. Interaction terms in logit and probit models. Economic Letters 2003, 80(1):123-129.
Baucells M., Weber M., Welfens F. Reference point formation and updating. Management Science 2011, 57(3):506-519.
Bebchuk L.A., Fried J.M. Executive compensation as an agency problem. Journal of Economic Perspectives 2003, 17(3):71-92.
Bebchuk L.A., Cohen A., Spamann H. The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008. Discussion Paper No. 657 2009, Harvard Law School.
Benartzi S., Thaler R.H. Myopic loss aversion and the equity premium puzzle. Quarterly Journal of Economics 1995, 110(1):75-92.
Bleichrodt H., Schmidt U., Zank H. Loss aversion in multiattribute utility theory. Management Science 2009, 55:863-873.
Booij A., van Praag B., van de Kuilen G. A parametric analysis of prospect theory's functionals for the general population. Theory and Decision 2010, 68(1-2):115-148.
Carpenter J.N. Does option compensation increase managerial risk appetite?. Journal of Finance 2000, 55:2311-2331.
Charness G., Gneezy U. Strong evidence for gender differences in risk taking. Journal of Economic Behavior and Organization 2012, 83(1):50-58.
Charness G., Jackson M.O. The role of responsibility in strategic risk taking. Journal of Economic Behavior and Organization 2009, 69:241-247.
Chou P.H., Chou R.K., Ko K.C. Prospect theory and the risk-return paradox: some recent evidence. Review of Quantitative Finance and Accounting 2009, 33(3):193-208.
Core J.E., Guay W.R., Larcker D.F. Executive equity compensation and incentives: a survey. Economic Policy Review 2003, 27-50.
DeFusco R.A., Johnson R.R., Zorn T.S. The effect of executive stock option plans on stockholders and bondholders. Journal of Finance 1990, 45(2):617-627.
Diecidue E., van de Ven J. Aspiration level, probability of success and failure, and expected utility. International Economic Review 2008, 49(2):683-700.
Fellner G., Sutter M. Causes, consequences, and cures of myopic loss aversion-an experimental investigation. The Economic Journal 2009, 119(537):900-916.
Feltham G.A., Wu M.G.H. Incentive efficiency of stock versus options. Review of Accounting Studies 2001, 6:7-28.
Fiegenbaum A. Prospect theory and the risk-return association. Journal of Economic Behavior and Organization 1990, 14:187-203.
Fox C.R., Rogers B.A., Tversky A. Options traders exhibit subadditive decision weights. Journal of Risk and Uncertainty 1996, 13:5-17.
Gneezy U., Potters J. An experiment on risk taking and evaluation periods. Quarterly Journal of Economics 1997, 112:631-646.
Greiner B. The Online Recruitment System ORSEE 2.0 - A Guide for the Organization of Experiments in Economics 2004, University of Cologne, Working Paper Series in Economics 10.
Guay W.R. The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants. Journal of Financial Economics 1999, 53:43-71.
Haigh M.S., List J.A. Do professional traders exhibit myopic loss aversion? Experimental analysis. Journal of Finance 2005, 60(1):523-534.
Hall B.J., Liebman J.B. Are CEOs really paid like beaurocrats?. Quarterly Journal of Economics 1998, 113(3):653-691.
Heath C., Huddart S., Lang M. Psychological factors and stock option exercise. Quarterly Journal of Economics 1999, 114(2):601-627.
Holden R.T. The original management incentive schemes. Journal of Economic Perspectives 2005, 19(4):135-144.
Holström B. Managerial incentive problems: a dynamic perspective. Review of Economic Studies 1999, 66(1):169-182.
Jegers M. Prospect theory and the risk-return relation: some Belgian evidence. The Academy of Management Journal 1991, 34(1):215-225.
Jensen M.C., Murphy K.J. CEO incentives: it's not how much you pay, but how. Harvard Business Review 1990, 3:138-153.
Kahneman D., Tversky A. Prospect theory: an analysis of decision under risk. Econometrica 1979, 47(2):263-291.
Köbberling V., Wakker P.P. An index of loss aversion. Journal of Economic Theory 2005, 122:119-131.
Lefebvre M., Vieider F.M. Reining in excessive risk taking by executives: the case of accountability. Theory and Decision 2013, 75(4):495-517.
List J.A., Mason C.F. Are CEOs expected utility maximizers?. Journal of Econometrics 2011, 162(1):114-123.
March J.G. Variable risk preferences and adaptive aspirations. Journal of Economic Behavior and Organization 1988, 9:5-24.
Mezias S.J. Aspiration level effects: an empirical investigation. Journal of Economic Behavior and Organization 1988, 10:389-400.
Pahlke J., Strasser S., Vieider F.M. Risk_taking for others under accountability. Economic Letters 2011, 114(1):102-105.
Piron R., Smith L.R. Testing risklove in an experimental racetrack. Journal of Economic Behavior and Organization 1995, 27:465-474.
Schmidt U., Zank H. Risk aversion in cumulative prospect theory. Management Science 2008, 54(1):208-216.
Segal U., Spivak A. First order versus second order risk aversion. Journal of Economic Theory 1990, 51:111-125.
Smith C.W., Stulz R.M. The determinants of Firms' Hedging Policies. The Journal of Financial and Quantitative Analysis 1985, 20(4):391-405.
Sutter M., Huber J., Kirchler M. Bubbles and information: an experiment. Management Science 2011, 58:384-393.
Tversky A., Kahneman D. Advances in prospect theory: cumulative representation of uncertainty. Journal of Risk and Uncertainty 1992, 5:297-323.
Wakker P.P. Prospect Theory for Risk and Ambiguity 2010, Cambridge University Press, Cambridge.
Weber M., Camerer C.F. The disposition effect in securities trading: an experimental analysis. Journal of Economic Behavior and Organization 1998, 33:167-184.
Wiseman R.M., Gomez-Mejia L.R. A behavioral agency model of managerial risk taking. Academy of Management Review 1998, 23(1):133-153.
Wu G., Gonzalez R. Curvature of the probability weighting function. Management Science 1996, 42(12):1676-1690.
Zeiliger R. A Presentation of Regate, Internet Based Software for Experimental Economics 2000, http://www.gate.cnrs.fr/~zeiliger/regate/RegateIntro.ppt, GATE, GATE, Lyon.
This website uses cookies to improve user experience. Read more
Save & Close
Accept all
Decline all
Show detailsHide details
Cookie declaration
About cookies
Strictly necessary
Performance
Strictly necessary cookies allow core website functionality such as user login and account management. The website cannot be used properly without strictly necessary cookies.
This cookie is used by Cookie-Script.com service to remember visitor cookie consent preferences. It is necessary for Cookie-Script.com cookie banner to work properly.
Performance cookies are used to see how visitors use the website, eg. analytics cookies. Those cookies cannot be used to directly identify a certain visitor.
Used to store the attribution information, the referrer initially used to visit the website
Cookies are small text files that are placed on your computer by websites that you visit. Websites use cookies to help users navigate efficiently and perform certain functions. Cookies that are required for the website to operate properly are allowed to be set without your permission. All other cookies need to be approved before they can be set in the browser.
You can change your consent to cookie usage at any time on our Privacy Policy page.
