THE FIT BETWEEN CEO COMPENSATION DESIGN AND FIRM RISK.

Abstract

We examined the effects of unsystematic and systematic firm risk on CEO compensation risk bearing and total pay. Both the proportion of variable pay in CEO pay packages and their magnitude are curvilinearly related to unsystematic firm risk—that is, they are highest under conditions of moderate firm-specific risk. Our results are consistent with agency theory predictions that both performance-contingent pay and the greater earnings potential associated with that form of pay are highest when an agent has greater control over performance outcomes.