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CEO compensation and corporate risk: Evidence from a natural experiment

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  • Gormley, Todd A.
  • Matsa, David A.
  • Milbourn, Todd

Abstract

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.

Suggested Citation

  • Gormley, Todd A. & Matsa, David A. & Milbourn, Todd, 2013. "CEO compensation and corporate risk: Evidence from a natural experiment," Journal of Accounting and Economics, Elsevier, vol. 56(2), pages 79-101.
    • Handle: RePEc:eee:jaecon:v:56:y:2013:i:2:p:79-101
    DOI: 10.1016/j.jacceco.2013.08.001
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    More about this item

    Keywords

    Legal liability; Regulatory risk; Tail risk; Stock options; Compensation; Managerial incentives;
    All these keywords.

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • K13 - Law and Economics - - Basic Areas of Law - - - Tort Law and Product Liability; Forensic Economics

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