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Managerial risk reduction, incentives and firm value

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  • Saltuk Ozerturk

Abstract

Empirical evidence suggests that managers privately alter the risk in their compensation by trading in the financial markets. This paper analyzes the implications of the manager’s hedging ability on her optimal compensation scheme, incentives and firm value. I allow the manager to reduce her systematic risk exposure by trading the market portfolio. I find that the manager’s optimal hedge depends on the liquidity of the market. Due to imperfect liquidity, the manager’s optimal hedge is not complete. The equilibrium pay-performance sensitivity and hence the manager’s equilibrium incentives and the firm value increases in the liquidity of the market. Copyright Springer-Verlag Berlin/Heidelberg 2006

Suggested Citation

  • Saltuk Ozerturk, 2006. "Managerial risk reduction, incentives and firm value," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(3), pages 523-535, April.
    • Handle: RePEc:spr:joecth:v:27:y:2006:i:3:p:523-535
    DOI: 10.1007/s00199-004-0569-2
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    Citations

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    Cited by:

    1. Avdjiev, Stefan & Zeng, Zheng, 2009. "Impact of heterogeneous managerial productivity on executive hedge markets in an asymmetric information environment," Finance Research Letters, Elsevier, vol. 6(4), pages 187-201, December.
    2. Luigi Iovino, 2012. "Sophisticated Intermediation and Aggregate Volatility," 2012 Meeting Papers 965, Society for Economic Dynamics.
    3. Saltuk Ozerturk, 2006. "Financial innovations and managerial incentive contracting," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 39(2), pages 434-454, May.
    4. Viral V. Acharya & Alberto Bisin, 2009. "Managerial hedging, equity ownership, and firm value," RAND Journal of Economics, RAND Corporation, vol. 40(1), pages 47-77, March.
    5. Choe, Chongwoo & Lien, Donald & Yu, Chia-Feng (Jeffrey), 2015. "Optimal managerial hedging and contracting with self-esteem concerns," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 354-367.
    6. Hung, Mao-Wei & Liu, Yu-Jane & Tsai, Chia-Fen, 2012. "Managerial personal diversification and portfolio equity incentives," Journal of Corporate Finance, Elsevier, vol. 18(1), pages 38-64.
    7. Lawrence P. Schrenk, 2008. "Executive Compensation And Macroeconomic Factors: Interest Rates And Corporate Taxation," Global Journal of Business Research, The Institute for Business and Finance Research, vol. 2(1), pages 125-135.
    8. Deng, Binbin, 2016. "A Simple Model of Managerial Incentives and Portfolio-Investment Decision," MPRA Paper 79959, University Library of Munich, Germany.

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