Managerial Performance Incentives and Firm Risk during Economic Expansions and Recessions*

We argue that the relationship between managerial pay-for-performance incentives and risk taking is procyclical. We study the relationship between incentives provided by stock-based compensation and rm risk for U.S. non- nancial corporations over the two business cycles between 1992 and 2009. We show that a given level of pay-for-performance incentives results in signi cantly lower rm risk when the economy is in a downturn. The documented procyclical relationship between incentives and risk taking is consistent with state-dependent risk aversion. Our ndings contribute to the literature on the depres- sive e¤ects of performance incentives on rm risk by documenting the importance of the interaction between performance incentives and risk aversion.