Explaining the structure of CEO incentive pay with decreasing relative risk aversion

Chaigneau, Pierre

doi:10.1016/j.jeconbus.2012.10.002

Cited by 11 publications

(5 citation statements)

References 64 publications

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“…where α 0 and α 1 are two constants which are determined to satisfy the participation constraint and the incentive constraint. Chaigneau (2011) shows that plausible preferences of the HARA class with decreasing absolute risk aversion and decreasing relative risk aversion can generate an optimal contract which closely matches a typical CEO compensation contract.…”

Section: Preliminary Analysis and Related Literaturementioning

confidence: 75%

“…Claim 2 (Chaigneau (2011)): With a lognormally distributed performance measure and a manager with HARA utility of the form u(W…”

Section: Preliminary Analysis and Related Literaturementioning

confidence: 99%

“…Comparing the result of Dittmann and Maug (2007) to that of Chaigneau (2011) shows that the form of the optimal contract is very sensitive to the postulated preferences of the manager. Likewise, comparing the result of Dittmann and Maug (2007) to that of Hemmer, Kim, and Verrecchia (2000) shows that, even with the same preferences (CRRA), the form of the optimal contract is very sensitive to the postulated probability distribution of performances.…”

Section: Preliminary Analysis and Related Literaturementioning

confidence: 99%

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The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts

Chaigneau

2012

SSRN Journal

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We use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by risk averse managers, in a fairly general setting. We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, prudence can contribute to explain the prevalence of stock-options in executive compensation. We also present a condition on the utility function which enables to compare the structure of optimal contracts associated with different risk preferences.

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Section: Preliminary Analysis and Related Literaturementioning

confidence: 75%

“…Claim 2 (Chaigneau (2011)): With a lognormally distributed performance measure and a manager with HARA utility of the form u(W…”

Section: Preliminary Analysis and Related Literaturementioning

confidence: 99%

Section: Preliminary Analysis and Related Literaturementioning

confidence: 99%

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The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts

Chaigneau

2012

SSRN Journal

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“…Both for insurance companies and investment brokers, the finding of decreasing relative risk aversion gives guidance on how insurance or investment products should change with increasing customer wealth to be as attractive as possible for consumers. Similarly, how risk aversion changes in wealth has implications for optimal contract design where incentive effects often have to be traded off against the risk premium charged by agents (Chaigneau, 2013).…”

Section: Discussionmentioning

confidence: 99%

On the change of risk aversion in wealth: a field experiment in a closed economic system

Huber¹,

Jaspersen²,

Richter³

et al. 2022

Exp Econ

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How does risk aversion change in wealth? To answer this question, we implemented a field experiment in the form of a free-to-play mobile game. Players made lottery choices at various points in the game and at different levels of in-game wealth. Since the game was designed as a closed economic system, that is, wealth could not be transferred into or out of the game, only in-game wealth was relevant for players’ choices. Analyzing the choices of over 2000 players, we find evidence for decreasing absolute risk aversion and decreasing relative risk aversion. We also find evidence of an “always safe” heuristic in a subgroup of decisions and observe a tendency of players to act according to the “hot hand fallacy”. Our research design allows us to exclude inertia and lets us analyze lottery stakes of significant size relative to in-game wealth. Our results render implications for theoretical research, empirical studies, and for the optimal design of financial products.

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“…Innes (1990) shows that stock options can be optimal in a model with limited liability and risk neutrality of both the principal and the agent. Chaigneau (2013a) explains the structure of CEO incentive pay with decreasing relative risk aversion.…”

Section: Modelmentioning

confidence: 99%

How Important Are Risk-Taking Incentives in Executive Compensation?*

Dittmann

Zhang

2017

Review of Finance

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We consider a model in which shareholders provide a risk-averse CEO with risktaking incentives in addition to effort incentives. We show that the optimal contract protects the CEO from losses for bad outcomes and is convex for medium outcomes and concave for good outcomes. We calibrate the model to data on 1,707 CEOs and show that it explains observed contracts much better than the standard model without risk-taking incentives. When we apply the model to contracts that consist of base salary, stock, and options, the results suggest that options should be issued in the money. Our model also helps us rationalize the universal use of at-the-money options when the tax code is taken into account. Moreover, we propose a new way of measuring risk-taking incentives in which the expected value added to the firm is traded off against the additional risk a CEO has to bear. JEL classification: G30, M52

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Explaining the structure of CEO incentive pay with decreasing relative risk aversion

Cited by 11 publications

References 64 publications

The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts

The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts

On the change of risk aversion in wealth: a field experiment in a closed economic system

How Important Are Risk-Taking Incentives in Executive Compensation?*

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