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The Effect of Risk on the CEO Market

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  • Alex Edmans
  • Xavier Gabaix

Abstract

This article presents a market equilibrium model of CEO assignment, pay, and incentives under risk aversion and moral hazard. Each of the three outcomes can be summarized by a single closed-form equation. In the presence of moral hazard, assignment is distorted from positive assortative matching on firm size as firms with higher risk or disutility choose less talented CEOs. Such firms also pay higher salaries in the cross-section, but economy-wide increases in risk or the disutility of being a CEO do not affect pay. The strength of incentives depends only on the disutility of effort and is independent of risk and risk aversion. If the CEO can affect firm risk, incentives rise and are increasing in risk and risk aversion. We calibrate the losses from various forms of poor corporate governance, such as failures in monitoring and inefficiencies in CEO assignment. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Alex Edmans & Xavier Gabaix, 2011. "The Effect of Risk on the CEO Market," The Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2822-2863.
    • Handle: RePEc:oup:rfinst:v:24:y:2011:i:8:p:2822-2863
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    File URL: http://hdl.handle.net/10.1093/rfs/hhq153
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