A trade-off between non-fundamental risk and incentives

Michael Fung ()

Review of Quantitative Finance and Accounting, 2013, vol. 41, issue 1, 29-51

Abstract: This study conjectures that CEOs are rewarded more heavily for fundamental than for non-fundamental performance, and that the impact of non-fundamental risks is more negative than that of fundamental risks on pay-performance sensitivity. While the first conjecture stems from the controllability principle, the second conjecture is attributable to the interplay between the risk-incentive trade-off and delegation of responsibility to the agent. This study devised measures for fundamental and non-fundamental performance using an ARIMA-based unobserved-component approach. The two conjectures are strongly supported by this study’s findings over a wide range of empirical specifications, indicating that the optimal level of pay-performance sensitivity depends not only on the degree, but also on the nature, of performance uncertainty. Copyright Springer Science+Business Media, LLC 2013

Keywords: CEO compensation; Performance decomposition; Fundamental risk; Non-fundamental risk; G3; J3; M4 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s11156-012-0299-7

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