Journal of Corporate Finance Vol. 19 2013
Production and hedging implications of executive compensation schemes
Abstract
This paper connects executive compensation with hedging and analyzes a crucial shareholders and managers agency source that evolves from the pricing of the hedging device. The shareholders are risk-neutral, while the risk-averse manager hedges the price risk of the manufactured quantity, and his compensation package includes equity-linked compensation-stock grants. Only when the hedging instrument's pricing includes a risk premium, hedging is costly to the shareholders, while it is costless to the manager. Then from the owners' point of view, we observe managerial over-hedging, increasing in the equity-linked compensation level. This result leads to a violation of the classical production and hedging separation theorem. We conclude that, in the case where the hedging device's pricing bears a risk premium, shareholders can regulate the corporate value diversion to managers through diminishing the managerial equity-linked compensation scheme or by putting restrictions on the extent of hedging activities of executives.
- DOI
- 10.1016/j.jcorpfin.2012.10.004
- Volume
- 19
- Pages
- 119-139
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref