Contracting Incentives and Compensation for Property‐Liability Insurer Executives

Abstract

This article examines several hypotheses about the structure and level of compensation for 103 property-liability chief executive officers (CEOs) from 1995 through 1997. The greater the level of firm risk and the larger the firm, the greater the use of incentive compensation. Insurers subject to more regulatory attention and those whose CEOs have greater stock ownership make less use of incentive compensation. There is some evidence that option grants and restricted stock awards provide CEOs with differing incentives. This article finds that corporate governance structures, managers' stock ownership, and regulatory attention are not adequate to prevent CEOs from receiving compensation levels in excess of what economic factors predict. Contrary to findings in prior studies, there is little evidence that use of incentive compensation or level of total compensation paid increases with insurer investment opportunities, as traditionally measured. Copyright The Journal of Risk and Insurance.

Corporate Governance and Risk Taking: Evidence From the U.K. and German Insurance Markets

“…The empirical evidence regarding the relationship between total executive compensation and firm risk is not entirely conclusive. Gray and Cannella (1997) find a negative relationship between risk taking and total compensation, but no significant relationship is found by Grace (2004). With regard to incentive compensation, option payments in particular are found to be positively related to firm risk (see Chen, Steiner, and Whyte, 2006;Milidonis and Stathopoulos, 2011).…”

“…However, Guay (1999) argues that executives' preference toward risk taking may depend on two 4 In addition to the risks modeled in this article, other types of risk often cannot be quantified but should be considered in risk management, such as operational risk or legal risk (see, e.g., Baranoff and Sager, 2002;Santomero and Babbel, 1997). 5 With regard to compensation, the structure of compensation and especially incentive compensation with convex payoffs affects the risk taking of insurance companies (Grace, 2004;Milidonis and Stathopoulos, 2011). Board monitoring and the independence of directors (see, e.g., Pathan, 2009) as well as the ownership structure (see, e.g., Cheng, Elyasiani, and Jia, 2011) have also been identified as relevant drivers of firm risk.…”

CEO Inside Debt and Risk Taking: Evidence From Property–Liability Insurance Firms

“…The previous literature linking insurer governance to risk taking has mainly focused on examining whether managerial risk-taking behavior is associated with equitybased incentive compensation (e.g., Grace, 2004;Milidonis and Stathopoulos, 2011), organizational or board structure (e.g., Lamm-Tennant and Starks, 1993;Ho, Lai, and Lee, 2013;Eling and Marek, 2014;Upadhyay, 2015), insider ownership (e.g., Downs and Sommer, 1999;Miller, 2011), and institutional ownership stability (Cheng, Elyasiani, and Jia, 2011). 2 Among them, Grace (2004) finds that there is no significant association between the use of incentive compensation and firm risk. Milidonis and Stathopoulos (2011) find that a large proportion of option-based compensation increases future firm default risk.…”

Do U.S. Insurance Firms Offer the “Wrong” Incentives to Their Executives?

“…Lamm‐Tennant and Starks (1993) use the variance of the loss ratio to show that stock insurers are more risky than mutual insurers. Grace (2004) finds that the use and level of incentive compensation are not linked to insurer investment opportunities, where firm risk is captured by the standard deviation of the ROA . Mayers and Smith (2010) use changes in ROA to proxy for risk and find significant correlations with changes in compensation.…”

“…Eckles and Halek (2010) link executive compensation bonuses and the exercising of stock options to insurer reserve errors. A few studies examine the relation between managerial incentives and firm risk using one‐dimensional proxies of firm risk (Grace, 2004; Lin and Lai, 2008; Browne, Ma, and Wang, 2009; Cheng, Elyasiani, and Jia, 2009; Eling and Marek, 2011). Traditionally, book variables have been the main focus, but more recently market variables have been employed to decompose total firm risk into systematic risk and unsystematic risk by using equity volatility, 1 firm beta, and residual volatility, respectively (e.g., Cheng, Elyasiani, and Jia, 2009; in the finance literature, Low, 2009).…”