Executive Compensation and Risk Taking: The Impact of Systemic Crises
It is widely accepted that managerial compensation packages contributed to the excessive risk-taking practices that led to the onset of the Great Recession (2007–2009). We argue that the relationship between managerial compensation and risk taking is procyclical. A given level of performance incentives may result in significantly lower firm risk when economy is in a systemic crisis because managers face an increased employment risk during economic downturns. Students of finance who will become policy makers or who will sit on compensation committees would benefit from realizing that in order to implement a given level of firm risk, managerial compensation packages may need to be adjusted according to the state of the economy.
KeywordsStock Option Financial Distress Executive Compensation Strike Price Firm Risk
We thank Iftekhar Hassan, the Editor of the Journal of Financial Stability for his valuable comments. We are also indebted for useful comments and suggestion to Jens Hilscher, Antoni Vaello Sebastià, Catherine Mann, David Yermack, Dan Zhang, the Editor and referees, as well as seminar participants at Brandeis University, Williams College, the 2011 FMA Annual Meeting in Denver, 2012 EFA Annual Meeting in Boston, the Ackerman Conference on corporate governance in Bar Ilan University, and the conference on Teaching Finance at Turbulent Times at Heilbronn University. Alon Raviv thanks the Raymond Ackerman Family Chair in Israeli Corporate Governance for its support.
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