Strategic Risk Taking, Executive Compensation and Financial Performance

In this paper, we show that the relation between CEO compensation, CEO risk taking and firm performance is not unilateral. Low-risk firms benefit from higher CEO compensation, whereas high-risk firms are affected adversely. Especially in high-risk firms, increased executive compensation can result in inferior performance due to greater risk-taking. Our findings have important implications for agency theory. We show that measures to structure executive compensation for low (high) risk firms align (misalign) the interests of executives and owners and incentivize CEOs to undertake strategic risks that enhance (deteriorate) firm performance. Our policy implications are in terms of discouraging short-termism and excessive risk-taking so as to protect the shareholders and society from possible harm. Compensation incentive schemes should be geared towards the attainment of prudent long-term assessment of risk and related revenue generation.