Uncertainty, Risk, and Incentives: Theory and Evidence

Zhiguo He (), Si Li (), Bin Wei and Jianfeng Yu ()
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Si Li: School of Business and Economics, Wilfrid Laurier University, Waterloo, Ontario N2L 3C5, Canada; and PBC School of Finance, Tsinghua University, 100083 Beijing, China
Jianfeng Yu: Carlson School of Management, University of Minnesota, Minneapolis, Minnesota 55455

Management Science, 2014, vol. 60, issue 1, 206-226

Abstract: Uncertainty has qualitatively different implications than risk in studying executive incentives. We study the interplay between profitability uncertainty and moral hazard, where profitability is multiplicative with managerial effort. Investors who face greater uncertainty desire faster learning, and consequently offer higher managerial incentives to induce higher effort from the manager. In contrast to the standard negative risk-incentive trade-off, this “learning-by-doing” effect generates a positive relation between profitability uncertainty and incentives. We document empirical support for this prediction. This paper was accepted by Wei Jiang, finance.

Keywords: executive compensation; optimal contracting; learning; uncertainty; risk--incentive trade-off (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (13)

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http://dx.doi.org/10.1287/mnsc.2013.1744 (application/pdf)

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Working Paper: Uncertainty, risk, and incentives: theory and evidence (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:60:y:2014:i:1:p:206-226

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