Does Option Compensation Increase Managerial Risk Appetite?

Carpenter, Jennifer N.

doi:10.1111/0022-1082.00288

Cited by 819 publications

(556 citation statements)

References 26 publications

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“…First, fees cannot be reinvested in the fund, but are confined to the safe asset. As in Carpenter (2000), Ross (2004), and Panageas and Westerfield (2009), this assumption prevents the manager from hedging the high water mark contract, thereby defeating its incentive purpose. Second, the manager invests according to a turnpike portfolio, which approximates the optimal portfolio for a manager with a long but finite horizon.…”

Section: Introductionmentioning

confidence: 99%

The Incentives of Hedge Fund Fees and High-Water Marks

Guasoni

Obłój

2011

SSRN Journal

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Hedge fund managers receive performance fees proportional to their funds' profits, plus regular fees proportional to assets. Managers with constant relative risk aversion, constant investment opportunities, maximizing utility of fees at long horizons, choose constant Merton portfolios. The effective risk aversion depends on performance fees, which shrink the true risk aversion towards one. Thus, performance fees have ambiguous risk-shifting implications, depending on managers' own risk aversion. Further, managers behave like investors acting on their own behalf, but facing drawdown constraints. A Stackelberg equilibrium between investors and managers trades off the costs of performance fees, with their potential to align preferences. Only aggressive investors voluntarily pay high performance fees, and only if managers are even more aggressive.

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Section: Introductionmentioning

confidence: 99%

The Incentives of Hedge Fund Fees and High-Water Marks

Guasoni

Obłój

2011

SSRN Journal

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“…Haugen and Senbet (1981) show that the mix of put and call options can mitigate the asset substitution problem. Carpenter (2000) argues that executive stock options may not necessarily encourage excessive risk-taking for risk-averse portfolio managers. However, her focus is on the manager's trading strategy, rather than on the characterization of an optimal contract with stock options.…”

Section: Introductionmentioning

confidence: 99%

Leverage, volatility and executive stock options

Choe

2003

Journal of Corporate Finance

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This paper studies how an optimal wage contract can be implemented using stock options, and derives the properties of the optimal contract with stock options. Specifically, we show how the exercise price and the size of the option grant should change in respose to changes in exogenous parameter. First, for a fixed exercise price of executive stock options, the size of the option grant decreases in the riskiness of a desired investment policy, decreases in the volatility of return from the risky project, and increases in leverage. Second, for a fixed size of the option grant, the optimal exercise price of managerial stock options increases in the riskiness of a desired investment policy, increases in the volatility of return from the risky project, and decreases in leverage. Several empirical predictions are drawn from these conclusions regarding the pay-performance sensitivity of management compensation.

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“…Hence, the investor with the same preferences as the entrepreneur optimally chooses the same risky wealth share as the optimal product novelty chosen by the entrepreneur. 21 As discussed in the portfolio choice literature (see, e.g., Carpenter (2000), Basak, Pavlova, and Shapiro (2007)), to solve our non-concave optimization problem in Definitions 1 and 2, we convert it into an equivalent concave problem by concavifying the entrepreneur's preferences.…”

Section: Resultsmentioning

confidence: 99%

Security Design with Status Concerns

et al. 2015

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This paper provides a status-based explanation for convertible securities. We consider a dynamic setting in which a status-driven entrepreneur with a project idea decides what security to issue to finance the project and how to manage the project over time. We solve the problem analytically and find that the optimal security is considerably similar to a convertible security. Our model can also explain why relatively riskier companies, such as start-ups or small firms, resort to convertible securities more often, as well as why these securities differ in their conversion ratios. The dynamic nature of our model is key to our results whereas asymmetric information and ensuing agency conflicts play no role, which makes our explanation of convertible securities notably different from existing ones.JEL Classifications: G32, C61, G24, D86.

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Does Option Compensation Increase Managerial Risk Appetite?

Cited by 819 publications

References 26 publications

The Incentives of Hedge Fund Fees and High-Water Marks

The Incentives of Hedge Fund Fees and High-Water Marks

Leverage, volatility and executive stock options

Security Design with Status Concerns

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