Managerial Hedging and Incentive Compensation in Stock Market Economies
نویسندگان
چکیده
Managerial Hedging and Incentive Compensation in Stock Market Economies Incentive compensation exposes managers to the risk of their firms. Managers can hedge their aggregate risk exposure by trading in financial markets, but cannot hedge their firmspecific exposure. This gives them an incentive to pass up firm-specific projects in favor of standard projects that contain greater aggregate risk. Such risk substitution gives rise to excessive aggregate risk in stock markets compared to the first-best allocation, and in turn, reduces the risk-sharing possible among stock market investors. Incentive compensation contract can be designed appropriately to mitigate this externality. The equilibrium incentive contract designed by entrepreneurs in the case of owner-managed firms, and by shareholders in the case of corporations run by managers, is characterized in a capital asset pricing model (CAPM) economy, and is compared to the first-best and the (second-best) constrained efficient contracts.
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