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Does option compensation increase managerial risk appetite (2000)
| Venue: | Journal of Finance |
| Citations: | 184 - 0 self |
BibTeX
@ARTICLE{Carpenter00doesoption,
author = {Jennifer N. Carpenter},
title = {Does option compensation increase managerial risk appetite},
journal = {Journal of Finance},
year = {2000},
pages = {2311--2331}
}
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Abstract
This paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls. Under the manager’s optimal policy, the option ends up either deep in or deep out of the money. As the asset value goes to zero, volatility goes to infinity. However, the option compensation does not strictly lead to greater risk seeking. Sometimes, the manager’s optimal volatility is less with the option than it would be if he were trading his own account. Furthermore, giving the manager more options causes him to reduce volatility. MANAGERS WITH CONVEX COMPENSATION SCHEMES play an important role in financial markets. This paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls. The paper focuses on how the option compensation impacts the manager’s appetite for risk when he cannot hedge the option position. On one hand, the convexity of the option makes the manager shun payoffs that are likely to be near the money. Under the optimal policy, the manager
