An Experimental Study of Managerial Pay and Firm Hedging Decisions

Abstract

A manager's pay is often a function of a performance measure such as revenue, profit, or asset value. This study tests directly by experimentation the implications of pay function shape and managerial risk taking. Greater convexity of pay functions motivated greater risk taking, but not to the extent predicted and with great variability, individually and across managers. Decisions by managers about the level of firm risk were found to be significantly context dependent, in that simply referring to a hedging decision as insuring motivated greater risk avoidance. Managers were also more likely to take greater risks when pay was expected to fall.