Publication Type

Working Paper

Publication Date

5-2015

Abstract

We use the introduction of exchange-traded weather derivative contracts as a natural experiment to examine the relation between risk and incentives. In particular, we examine how executives’ ability to hedge uncontrollable weather-related risk that was previously difficult and costly to manage influences the design of executives’ incentive-compensation contracts. We also examine the whether the ability to hedge this important source of uncontrollable risk affects executives’ subsequent risk-taking. We find that the CEOs of firms that are relatively more exposed to uncontrollable weather risk—and therefore stand to benefit the most from hedging this source of risk—receive less annual compensation and have fewer equity incentives following the introduction of weather derivatives. We attribute the decline in annual compensation to a reduction in the risk premium that CEOs demand for exposure to uncontrollable risk. We attribute the decline in equity incentives to stock price becoming a more precise measure of CEOs’ actions—and therefore a more informative performance measure—so that fewer shares of stock and stock options are required to provide the same total incentives.

Keywords

Clawbacks, Co-opted boards, Corporate governance

Discipline

Accounting

Research Areas

Corporate Reporting and Disclosure

First Page

1

Last Page

43

Copyright Owner and License

Authors

Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

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