Competitive Pay and Excessive Manager Risk-taking
Jen Wen Chang and
Simpson Zhang ()
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Simpson Zhang: Office of Financial Research
No 18-02, Working Papers from Office of Financial Research, US Department of the Treasury
Since the 2007-09 financial crisis, researchers have debated whether compensation plans drove excessive risk-taking or financial managers simply underestimated the risks of various investments. Through a principal-agent model with heterogeneous beliefs, we show that principals offer contracts that incentivize safe behavior when competition for managerial talent is low. However, intense competition results in contracts that incentivize risk-taking. We find that factors that increase the intensity of competition include greater search efficiency, larger project scales, and higher debt funding, all of which may be prevalent during a financial bubble.
Keywords: competition; compensation constracts; overoptimism (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:ofr:wpaper:18-02
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