Managerial Hedging and Portfolio Monitoring

Alberto Bisin (), Piero Gottardi () and Adriano A. Rampini ()

No CESifo Working Paper No. 1322, CESifo Working Paper Series from CESifo Group Munich

Abstract: Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his incentive compensation using financial markets and shareholders cannot perfectly monitor the manager’s portfolio in order to keep him from hedging the risk in his compensation. In particular, shareholders can monitor the manager’s portfolio stochastically, and since monitoring is costly governance is imperfect. If managerial hedging is detected, shareholders can seize the payoffs of the manager’s trades. We show that at the optimal contract: (i) the manager’s portfolio is monitored only when the firm performs poorly, (ii) the more costly monitoring is, the more sensitive is the manager’s compensation to firm performance, and (iii) conditional on the firm’s performance, the manager’s compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring.

Keywords: executive compensation; incentives; monitoring; corporate governance. (search for similar items in EconPapers)
JEL-codes: D82 G30 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin
Date: 2004
View list of references View citations in EconPapers

Downloads: (external link)
http://www.cesifo-group.de/DocCIDL/cesifo1_wp1322.pdf (application/pdf)

Related works:
Working Paper: Managerial Hedging and Portfolio Monitoring (2007)
Journal Article: Managerial Hedging and Portfolio Monitoring (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:ces:ceswps:_1322

Access Statistics for this paper

More papers in CESifo Working Paper Series from CESifo Group Munich
Address: Poschingerstrasse 5, 81679 Munich
Series data maintained by Julio Saavedra ().