Risk-Taking and CEO Compensation: CEO Pay Slice Versus Pay-Volatility Sensitivity

Abstract

This paper aims to analyze the impacts of compensation incentives and CEO power on firm’s risk-taking by using stock return volatility (Srisk) and earnings volatility (Erisk) as the proxies of firm’s risk-taking level, and by using pay-volatility sensitivity (PVS) and CEO-pay slice (CPS) as the proxies of compensation incentives and CEO power, respectively. By applying ordinary least square (OLS) regression and two-stage least square (2SLS) regression on obtained data, this paper provides strong empirical evidence that PVS and CPS have negative impact on earnings volatility and stock return volatility. In addition, the negative impact of PVS on managerial risk-taking is greater for CEOs with lower CPS than that for CEOs with higher CPS. That is, EBC discourages CEOs from taking more risks, and more powerful CEOs are less risk-averse than less powerful CEOs when granted EBC.