Reining in Excessive Risk Taking by Executives: Experimental Evidence

Mathieu Lefebvre and Ferdinand Vieider ()

No 1006, Working Papers from Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon

Abstract: Compensation of executives by means of equity has long been seen as a means to tie executives? income to company performance, and thus as a solution to the principal-agent dilemma created by the separation of ownership and management in publicly owned companies. The overwhelming part of such equity compensation is currently provided in the form of stock-options. Recent events have however revived suspicions that the latter may induce excessive risk taking by executives. In an experiment, we find that subjects acting as executives do indeed take risks that are excessive from the perspective of shareholders if compensated through options. Comparing compensation mechanisms based on stock-options to long-term stock-ownership plans, we find that the latter significantly reduce the uptake of excessive risks by aligning the executives? interests with those of shareholders. Introducing an institutionalized accountability mechanism consisting in the requirement for executives to justify their choices in front of a shareholder reunion also reduces excessive risk taking, and appears to be even more effective than long-term stock-ownership plans. A combination of long-term stock-ownership plans and increased accountability thus seem a promising direction for reining in excessive risk taking by executives.

Keywords: executive compensation; stock-options; incentives; accountability; risk taking (search for similar items in EconPapers)
JEL-codes: D03 G28 G32 J33 L22 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2010
New Economics Papers: this item is included in nep-exp and nep-rmg
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Citations: View citations in EconPapers (2)

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Working Paper: Reining in Excessive Risk Taking by Executives: Experimental Evidence (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:gat:wpaper:1006

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