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A trade-off between non-fundamental risk and incentives

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  • Michael Fung

Abstract

This study conjectures that CEOs are rewarded more heavily for fundamental than for non-fundamental performance, and that the impact of non-fundamental risks is more negative than that of fundamental risks on pay-performance sensitivity. While the first conjecture stems from the controllability principle, the second conjecture is attributable to the interplay between the risk-incentive trade-off and delegation of responsibility to the agent. This study devised measures for fundamental and non-fundamental performance using an ARIMA-based unobserved-component approach. The two conjectures are strongly supported by this study’s findings over a wide range of empirical specifications, indicating that the optimal level of pay-performance sensitivity depends not only on the degree, but also on the nature, of performance uncertainty. Copyright Springer Science+Business Media, LLC 2013

Suggested Citation

  • Michael Fung, 2013. "A trade-off between non-fundamental risk and incentives," Review of Quantitative Finance and Accounting, Springer, vol. 41(1), pages 29-51, July.
    • Handle: RePEc:kap:rqfnac:v:41:y:2013:i:1:p:29-51
    DOI: 10.1007/s11156-012-0299-7
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    More about this item

    Keywords

    CEO compensation; Performance decomposition; Fundamental risk; Non-fundamental risk; G3; J3; M4;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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