This thesis studies the effects of share-based pay on managerial risk-taking. At first, the
relationship between managers and shareholders as predicted by agency theory is described to
motivate the use of share-based pay. Then, the influence of manager-specific attributes and
compensation design on the risk premium and the risk incentives is discussed Theoretical and
empirical research findings are presented and discussed to gain insights into the determinants
and effects of stock-based compensation. Last but not least, a descriptive analysis of the payperformance
sensitivities of the stock and option portfolios of board members in the German
DAX and MDAX in the period of 2006 to 2010 is conducted.
Zusammenfassung
Die vorliegende Arbeit untersucht die Auswirkungen von aktienkursorientierter Vergütung
auf das Risikoverhalten von Managern. Basierend auf den Vorhersagen des Principal-
Agenten-Modells wird zunächst die Beziehung zwischen Aktionären und dem Vorstand
beschrieben, um die Verwendung aktienkursorientierter Vergütung zu begründen.
Darauffolgend wird der Einfluss von managerspezifischen Eigenschaften und der
Vergütungsstruktur auf die Risikoprämie und die Risikoanreize dargelegt. Zur Identifizierung
der Determinanten und Konsequenzen von aktienkursorientierte Vergütung werden
theoretische und empirische Forschungsergebnisse präsentiert und diskutiert. Abschließend
wird eine deskriptive Analyse der Unternehmensleistungssensitivitäten von Aktien- und
Aktienoptionsportfolios von Vorständen aus DAX und MDAX in der Periode von 2006 bis
2010 durchgeführt.
Table of Contents
1 The growing use of stock-based compensation
2 The diverging risk preferences of principal and agent
3 Overcoming managerial risk aversion
4 The risk premium on share-based pay
4.1 The influence of the exercise price, degree of diversification and the risk aversion parameter on the risk premium of the manager
4.2 The importance to distinguish between firm-specific and systematic risk when the market portfolio can be traded
4.3 Implications for the use of share-based pay and research on the effects of share-based pay
5 Theoretical predictions on the risk incentives provided by share-based pay
5.1 The effects of managerial risk aversion and compensation design on risk incentives provided by share-based pay
5.2 The incentives provided by share-based pay regarding total risk
5.3 The effects provided by share-based pay to change systematic risk, firm-specific risk and the correlation between company returns and market returns
6 Empirical findings on the relationship between share-based pay and company risk
6.1 Estimating the sensitivities to stock price and stock volatility of a manager’s portfolio with the “one-year” approach
6.2 The joint determination of firm risk characteristics and share-based pay
6.3 The incentives provided by vega and delta to change the components of risk
7 Descriptive analyses of the pay-performance sensitivities of German DAX and MDAX executives
7.1 Sample description
7.2 Calculation of the pay-performance sensitivity
7.3 The alignment of DAX and MDAX board members
8 Summary of results
Research Objective and Core Themes
This thesis examines the influence of share-based compensation on the risk-taking behavior of corporate managers, analyzing the alignment between management and shareholder interests through the lens of agency theory and empirical performance-sensitivity data.
- Agency theory and the diverging risk preferences of principals and agents.
- Theoretical determinants of managerial risk-taking influenced by compensation design.
- Empirical analysis of pay-performance sensitivities (vega and delta) in German DAX and MDAX companies.
- The role of systematic versus firm-specific risk in incentive alignment.
- Methodological considerations for estimating portfolio sensitivities using the "one-year" approach.
Excerpt from the Book
4.1 The influence of the exercise price, degree of diversification and the risk aversion parameter on the risk premium of the manager
Hall and Murphy (2002) use a “certainty-equivalence” approach to estimate the value of a non-tradable option to an undiversified risk-averse executive by determining the amount of cash the executive would exchange for the option. They define the executive’s wealth at time T as follows. W is the amount of non-firm related wealth that is invested at the risk-free rate r_f, s is the number of shares held by the executive, n is the number of options awarded to the manager with exercise price X and P_T is the stock price at time T:
W_T = W(1 + r_f)^T + sP_T + n max (0, P_T - X)
If he would receive the amount of cash V that is also invested at the risk-free rate his wealth at time T would be:
W_T^V = (w + V)(1 + r_f)^T + sP_T
The executive’s utility as a function of his wealth is defined as U(W). The value of the n options to the manager is defined as the certainty equivalent V that equates the utilities:
∫ U(W_T^V)f(P_T)dP_T = ∫ U(W_T)f(P_T)dP_T
This means V is the amount of cash that is of equal value to the executive owning n options.
Summary of Chapters
1 The growing use of stock-based compensation: Discusses the rising prevalence of stock-based pay in corporate governance and the public debate regarding its role in executive remuneration.
2 The diverging risk preferences of principal and agent: Explores agency theory foundations, explaining why managers and shareholders have different attitudes toward corporate risk.
3 Overcoming managerial risk aversion: Examines compensation mechanisms designed to align management incentives with value-maximizing behavior despite inherent managerial risk aversion.
4 The risk premium on share-based pay: Analyzes how factors like exercise price and diversification influence the subjective value of non-tradable options to risk-averse executives.
5 Theoretical predictions on the risk incentives provided by share-based pay: Reviews models that assess how compensation design impacts total, systematic, and firm-specific risk-taking.
6 Empirical findings on the relationship between share-based pay and company risk: Details empirical research on how portfolio sensitivities (vega and delta) correlate with actual corporate risk policies.
7 Descriptive analyses of the pay-performance sensitivities of German DAX and MDAX executives: Presents a descriptive analysis of alignment values in German firms between 2006 and 2010.
8 Summary of results: Concludes the thesis by synthesizing theoretical predictions and empirical findings regarding equity-based incentives and managerial behavior.
Keywords
Share-based pay, Managerial risk-taking, Agency theory, Risk premium, Stock options, Vega, Delta, Pay-performance sensitivity, Corporate governance, Risk aversion, Systematic risk, Idiosyncratic risk, DAX, MDAX, Executive compensation.
Frequently Asked Questions
What is the primary focus of this thesis?
The thesis investigates how share-based compensation affects the risk-taking behavior of corporate managers, specifically focusing on whether these incentives effectively align managerial interests with shareholder value-maximization.
What theoretical framework is used to explain these effects?
The study primarily utilizes agency theory to analyze the inherent conflicts between the principal (shareholders) and the agent (management) regarding risk preferences.
What is the main objective of the research?
The goal is to determine if stock-based compensation successfully motivates managers to undertake risky, value-adding projects, or if it leads to suboptimal behavior due to managerial risk aversion.
Which methodology is employed for the empirical part?
The study utilizes the "one-year" approach developed by Core and Guay (2002) to estimate the value and sensitivities (vega and delta) of managerial option portfolios.
What are the primary components of the main part of the thesis?
The main part covers the theoretical link between compensation and risk preferences, the derivation of risk premiums, theoretical predictions of risk incentives, and empirical findings using market data from the DAX and MDAX.
Which keywords best describe the paper's scope?
Key terms include share-based pay, managerial risk-taking, agency theory, vega, delta, pay-performance sensitivity, and executive compensation.
How does "vega" relate to managerial risk-taking?
Vega represents the sensitivity of a manager's option portfolio to stock return volatility, providing an incentive for managers to increase or decrease firm-level risk.
What is the "one-year" approach?
It is a practical method used in empirical research to estimate the value and sensitivities of an executive's option portfolio using data readily available in current annual reports.
Why does the study differentiate between systematic and idiosyncratic risk?
Differentiation is crucial because managers cannot easily diversify their human capital, leading them to respond differently to systematic risks that can be hedged and firm-specific risks that cannot.
What were the main findings regarding German executives?
The descriptive analysis showed that the pay-performance sensitivity (alignment) of German DAX and MDAX board members is significantly lower compared to US-based counterparts.
- Citation du texte
- Patrick Gebhard (Auteur), 2013, Share-based pay and its effects on managerial risk-taking, Munich, GRIN Verlag, https://www.grin.com/document/211464
