Are CEOs Encouraged to Take Too Much Risk?

CEO compensation typically consists of cash and long-term equity. While the benefits of cash are to some extent fixed, the value of equity-based compensation depends on the market value of the firm. The latter is the key mechanism for motivating managers to act in the best interest of shareholders’ long-term wealth.

In order to maximize the incentives provided by the equity component of their compensation, executives should take risks to maximize their firm’s market value. How they do so can, of course, vary. The most desirable approach would be to engage in more risky projects that would bring long-term returns. … Read more