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CEO risk‐taking incentives and relative performance evaluation
Author(s) -
Black Dirk E.
Publication year - 2020
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/acfi.12372
Subject(s) - incentive , executive compensation , stock options , business , systematic risk , hedge fund , economics , microeconomics , finance
This paper examines how changes in CEO risk‐taking incentives are associated with changes in the use of relative performance evaluation ( RPE ) in CEO contracts. Using a shock to the accounting for executive stock options ( FAS 123R), I confirm that risk‐taking incentives and option grants declined following FAS 123R using a within‐firm design, but not a within‐ CEO ‐firm design. Decreased risk‐taking incentives lead executives to invest in projects with lower systematic risk and can result in reduced incentives to hedge exposure to systematic risk in CEO compensation contracts via RPE . However, CEO relative risk aversion increases with decreases in risk‐taking incentives, potentially increasing incentives to protect CEO wealth from systematic performance via RPE . Testing these competing predictions, I find modest evidence consistent with reduced RPE surrounding FAS 123R, suggesting that when CEO risk‐taking incentives are reduced, so are incentives to shield CEO pay from systematic performance.