Dynamic risk taking with bonus schemes

This paper studies dynamic risk taking by a risk-averse manager who receives a bonus; the company may default on its contractual obligations (debt and fixed compensation). We show that risk taking is time independent, and is summarized by the so-called risk aversion of derived utility. We highlight...

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Bibliographic Details
Published in:Quantitative finance 2015-09, Vol.15 (9), p.1583-1596
Main Author: Leisen, Dietmar P.J.
Format: Article
Language:English
Subjects:
Bonus
Bonuses
Default
Deferred compensation
Executive compensation
Incentives
Inside debt
Risk
Risk aversion
Studies
Utility functions
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Summary:This paper studies dynamic risk taking by a risk-averse manager who receives a bonus; the company may default on its contractual obligations (debt and fixed compensation). We show that risk taking is time independent, and is summarized by the so-called risk aversion of derived utility. We highlight the importance of dynamic aspects and provide a foundation for common qualitative discussions that are based on characteristics of bonus functions. The paper cautions that deferral of fixed compensation may increase risk taking. Finally, we motivate a new bonus scheme that incentivizes the manager to implement the socially optimal risk level.
ISSN:1469-7688
1469-7696
DOI:10.1080/14697688.2014.969299