EXECUTIVE SHORT-TERM INCENTIVE, RISK-TAKING AND LEVERAGE-NEUTRAL INCENTIVE SCHEME

Guy Kaplanski and Haim Levy ()
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Haim Levy: The Hebrew University of Jerusalem and The Center for Law and Business, Israel

Annals of Financial Economics (AFE), 2012, vol. 07, issue 01, 1-45

Abstract: In 23 out of 26 US industries, the annual CEO bonus is larger than the annual salary, suggesting that the bonus strongly affects the CEO's decisions. As the high leverage of financial institutions is often blamed for the 2008 financial crises, in this study we focus on leverage as a factor determining risk, particularly in financial institutions. The typical bonus scheme is not a leverage-neutral bonus scheme (LNBS), as the agent's optimal policy is to employ a corner solution: either zero or exteremely high leverage. Thus, consistent with Ross (2004), the bonus scheme does not neccesarily induce the agent to take greater risks. However, although more leverage is not prefered by all preferences, in most cases it is prefered. Thus, we suggest a combination of incentive parameters, which makes the agent indifferent to leverage, thereby preventing conflict beween the agent and the principal (stockholders).

Keywords: Executive compensations; leverage-neutral bonus scheme; bonus cap; risk-taking; JEL Classifications: G3; JEL Classifications: G38; JEL Classifications: J33; JEL Classifications: M52 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (4)

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DOI: 10.1142/S2010495212500030

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