Are CEOS Paid Extra for Riskier Pay Packages?
66 Pages Posted: 13 Aug 2018 Last revised: 18 Dec 2020
Date Written: December 11, 2020
This paper quantifies the cost of CEO incentive compensation by estimating an elasticity of pay to
the variance of pay. This metric is based on the benchmark moral hazard model widely used to
study CEO pay. Using US CEO compensation data and a variety of empirical approaches, we find
that CEOs with riskier pay packages are paid more. However, the estimated elasticity of pay to the
variance of pay is small. This small elasticity implies a low risk aversion coefficient for CEOs and
a risk premium that is at most 12% of total pay. This risk premium is about evenly split between
compensation for risk in cash bonus, stock grants, and option grants. Overall, our findings suggest
that incentive pay is not too costly for firms from a risk-diversification perspective, which may
explain the heavy reliance on incentive pay by US firms, and cast doubt on the ability of the
benchmark moral hazard model to explain CEO pay in the US.
Keywords: CEO pay, incentives, contract theory, risk aversion, moral hazard, participation constraint, realized variance, ARCH, Incentive Lab
JEL Classification: D81, G30, J33, M52
Suggested Citation: Suggested Citation