DP15243 Are CEOs paid extra for riskier pay packages?

Author(s): Rui Albuquerque, Ana Albuquerque, Mary Ellen Carter, Flora Dong
Publication Date: September 2020
Keyword(s): ARCH, CEO pay, Contract Theory, Incentive Lab, incentives, moral hazard, participation constraint, realized variance, risk aversion
JEL(s): D81, G30, J33, M52
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15243

This paper quantifies the cost of CEO incentive compensation by estimating an elasticity of pay to the variance of pay. Using US CEO compensation data and a variety of empirical approaches, we find that CEOs with riskier pay packages are paid more. However, increasing incentives by 20% is associated with an increase in expected pay of only 2%, on average. This small elasticity suggests that incentive pay is not too costly for firms as these seem to be able to substitute incentive pay for salary. In the context of a theorical model, we show that the small elasticity implies a low risk aversion coefficient for CEOs.