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Idiosyncratic risk and the manager

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  • Glover, Brent
  • Levine, Oliver

Abstract

We develop a model to characterize and quantify the effects of stock, option, and fixed compensation on a manager’s risk-taking incentive and investment choice. We find the average chief executive officer’s (CEO) compensation contract incentivizes overinvestment by 1.3 percentage points per year, with significant variation across firms and over time. We estimate a value of CEO effort implied by compensation contracts and find it to be strongly related to firm intangibility. Finally, we assess the effects on investment of FAS 123R and a hypothetical ban on option grants and find heterogeneous responses that depend on firm volatility and the prior structure of compensation.

Suggested Citation

  • Glover, Brent & Levine, Oliver, 2017. "Idiosyncratic risk and the manager," Journal of Financial Economics, Elsevier, vol. 126(2), pages 320-341.
    • Handle: RePEc:eee:jfinec:v:126:y:2017:i:2:p:320-341
    DOI: 10.1016/j.jfineco.2017.07.003
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    More about this item

    Keywords

    Corporate investment; Executive compensation; Managerial incentives; Agency conflicts; Risk taking;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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