Year: 2012
Type: book
Abstract: We propose a new theory of suboptimal risk-taking based on contractual externalities. We examine an industry with a continuum of _rms. Each _rm's manager exerts costly hidden e_ort. The productivity of e_ort is subject to systematic shocks. Firms' stock prices reect their performance relative to the industry average. In this setting, stock-based incentives cause complementarities in managerial e_ort choices. Externalities arise because shareholders do not internalize the impact of their incentive provision on the average e_ort. During booms, they over-incentivise managers, triggering a rat-race in e_ort exertion, resulting in excessive risk relative to the second-best. The opposite occurs during busts.
Authors: Emre Ozdenoren, Kathy Yuan
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W1515734584