Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Risk Choices and Compensation Design
We analyze the impact of bad-tail risks on managerial pay functions, especially the decision to pay managers in stock or in options. In contrast to conventional wisdom, we find that options are often a superior vehicle for limiting managerial incentives to take bad-tail risks while providing incentives to exert effort. Arrangements similar to collar options are able to incent the desired project choice in wider range of circumstances than call options or stock. However, information requirements appear high. We briefly explore alternatives with features similar to maluses and clawbacks, which are a bit like weakening the limited liability of managers.
Cite this item
Mark S. Carey & Bo Sun, Risk Choices and Compensation Design, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1130, 26 Jan 2015.
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
Keywords: Compensation; Bad tail risk
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