Trade‐off Between Risk and Incentives: Evidence from New‐ and Old‐Economy Firms
Abstract
The sensitivity of managerial compensation to the firm's risk is a controversial issue. While some articles find evidence supporting the agency theory that predicts a negative relationship between pay‐performance sensitivity and risk, others support the managerial ownership that predicts a positive relationship between these factors. This article reconciles these theories and provides evidence that these two theories are not conflicting, when tested properly, using industries risk characteristics. In this articled, we distinguish between new‐ and old‐economy industries, and demonstrate that managerial ownership theory applies to new‐economy firms, which are high‐tech firms that operate in more uncertain environments, whereas the agency theory applies to old‐economy firms that operate in more traditional industries. We further control for the size effect and find a positive relationship between pay‐performance sensitivity and risk for medium and large size new‐economy firms. Furthermore, we find that high‐tech companies increased their CEOs noncash compensation dramatically during the high‐tech market crash between 2000 and 2002 to cushion the fall in their CEOs wealth in the company. This caused CEOs pay‐performance sensitivity to risk to become negatively related to their firms' risk during that period. © 2016 Wiley Periodicals, Inc.
Description
This article is not available at CUD collection. The version of scholarly record of this article is published in International Journal of Corporate Accounting & Finance (2016), available online at: https://doi.org/10.1002/jcaf.22122
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Article
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Keywords
Executive compensation, Business enterprises, Chief executive officers, Probability theory, Wages
Citation
Tebourbi, I. (2016), Trade‐off Between Risk and Incentives: Evidence from New‐ and Old‐Economy Firms. Journal of Corporate Accounting & Finance, 27(2), 53-71. https://doi.org/10.1002/jcaf.22122