Publication Type

Journal Article

Version

acceptedVersion

Publication Date

7-2022

Abstract

We examine how executives' ability to control their firms' exposure to risk affects the design of their incentive-compensation contracts. Our natural experimental evidence shows that exchange-traded weather derivatives allow executives to control their firms' exposure to weather risk. Once these derivatives became available, those executives who use them to hedge experience relative reductions in their total compensation and equity incentives. The decline in compensation is consistent with a reduction in the risk premium that executives receive for exposure to weather risk. The decline in equity incentives is consistent with the relation between risk and incentives shifting in a complementary direction when executives can better control their firms' exposure to risk. Collectively, our findings provide evidence that executives' ability to control their firms' exposure and, by extension, their own to an important source of risk influences the design of their incentive-compensation contracts.

Keywords

executive compensation, contract design, equity incentives, risk-taking incentives, stock options, derivatives, hedging, natural experiment

Discipline

Accounting | Corporate Finance

Research Areas

Corporate Governance, Auditing and Risk Management

Publication

Accounting Review

Volume

97

Issue

4

First Page

27

Last Page

50

ISSN

0001-4826

Identifier

10.2308/TAR-2018-0265

Publisher

American Accounting Association

Embargo Period

1-11-2023

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.2308/TAR-2018-0265

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