Introducing convexity into optimal compensation contracts

Hemmer, Thomas; Kim, Oliver; Verrecchia, Robert E.

doi:10.1016/s0165-4101(00)00008-2

Cited by 159 publications

(109 citation statements)

References 7 publications

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“…Hemmer, Kim, and Verrecchia (1999), and Hirshleifer and Suh (1992) show that options help mitigate the effects of executive risk aversion by giving managers incentives to adopt rather than avoid risky projects. Smith and Watts (1992), Gaver and Gaver (1993), and Bryan, Hwang, and Lilien (2000) find that firms with greater investment opportunities use options more frequently as a part of the CEO's compensation package and Guay (1999) shows that ESO risk incentives are positively related to firms' investment opportunity sets.…”

Section: Hypotheses Development and Conceptual Empirical Modelmentioning

confidence: 99%

“…A considerable body of theory posits that employee stock options (ESOs) offer incentives to risk-averse managers to invest in high-risk high-return projects on behalf of risk-neutral shareholders (e.g., Jensen and Meckling 1976;Haugen and Senbet 1981;Smith and Stulz 1985;Lambert 1986;Copeland and Weston 1988;Lambert, Larcker, and Verrecchia 1991;Hirshleifer and Suh 1992;Murphy 1998;and Hemmer, Kim, and Verrecchia 1999). However, there is little direct empirical evidence on whether ESOs affect managers' decisions to undertake more risky but positive net present value and hence firm-value-increasing projects.…”

Section: Introductionmentioning

confidence: 99%

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Empirical Evidence on the Relation Between Stock Option Compensation and Risk Taking

Rajgopal¹,

Shevlin

1999

SSRN Journal

141

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We examine whether executive stock options (ESOs) provide managers with incentives to invest in risky projects. For a sample of oil and gas producers, we examine whether the coefficient of variation of future cash flows from exploration activity (our proxy for exploration risk) increases with the sensitivity of the value of the CEO's options to stock return volatility (ESO risk incentives). Both ESO risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach.We find evidence that ESO risk incentives has a positive relation with future exploration risk taking. Additional tests indicate that ESO risk incentives exhibit a negative relation with oil price hedging in a system of equations where ESO risk incentives and hedging are allowed to be endogenously determined. Overall, our results are consistent with ESOs providing managers with incentives to mitigate risk-related incentive problems.

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Section: Hypotheses Development and Conceptual Empirical Modelmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Empirical Evidence on the Relation Between Stock Option Compensation and Risk Taking

Rajgopal¹,

Shevlin

1999

SSRN Journal

141

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“…Grinblatt and Titman (1989) show that fund managers who hedge their incentive fees try to maximize the value of the fees by increasing fund leverage as much as possible. A considerable body of theory posits that equity-based compensation is awarded to managers to overcome managerial risk aversion and encourage them to invest in high-risk, high-return projects on behalf of risk-neutral shareholders (see for example Haugen and Senbet 1981;Smith and Stulz 1985;Lambert 1986;Copeland and Weston 1988;Lambert, Larcker and Verrecchia 1991;Hirshleifer and Suh 1992;Murphy 1999;Hemmer, Kim and Verrecchia 1999). In their empirical study, Massa and Patgiri (2009) find that the incentives contained in contracts have a positive effect on fund risk-taking in the mutual fund industry.…”

Section: The Effect Of Pay-performance Sensitivity On Fund Riskmentioning

confidence: 99%

Pay-performance sensitivity and risk-taking behaviors: Evidence from closed-end funds

Yang

Hou

2016

Emerging Markets Review

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The pay-performance sensitivity (PPS) of managers of closed-end funds is explicitly specified in their contracts as the marginal rate of the funds' net asset value. Using a sample of US closed-end funds from 2006 to 2009, this paper investigates the relationship between the PPS and risk-taking behaviors of fund managers. After controlling for endogeneity, we find that fund return volatility and fund PPS positively determine each other. Furthermore, the positive relationship is more pronounced for closed-end funds engaging in alternative investments or in emerging markets.

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“…Hemmer, Kim, and Verrecchia (1999) present a model that introduces options into CEO compensation to incentivize greater risk-taking. Guay (1999) provides empirical support for the proposition that boards manage equity risk by awarding convex payoff compensation (option grants).…”

Section: Previous Literature and Hypothesis Developmentmentioning

confidence: 99%

Wealth Shocks and Executive Compensation: Evidence from CEO Divorce

Neyland

2012

SSRN Journal

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Introducing convexity into optimal compensation contracts

Cited by 159 publications

References 7 publications

Empirical Evidence on the Relation Between Stock Option Compensation and Risk Taking

Empirical Evidence on the Relation Between Stock Option Compensation and Risk Taking

Pay-performance sensitivity and risk-taking behaviors: Evidence from closed-end funds

Wealth Shocks and Executive Compensation: Evidence from CEO Divorce

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