TY - JOUR
T1 - Managerial hedging and portfolio monitoring
AU - Bisin, Alberto
AU - Gottardi, Piero
AU - Rampini, Adriano A.
PY - 2008/3
Y1 - 2008/3
N2 - Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his compensation using financial markets and shareholders can monitor the manager's portfolio in order to keep him from hedging, but monitoring is costly. We find that the optimal incentive compensation and governance provisions have the following properties: (i) the manager's portfolio is monitored only when the firm performs poorly, (ii) the manager's compensation is more sensitive to firm performance when the cost of monitoring is higher or when hedging markets are more developed, and (iii) conditional on the firm's performance, the manager's compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring. Moreover, the model suggests that the optimal level of portfolio monitoring is higher for managers of firms whose performance can be hedged more easily, such as large firms and firms in more developed financial markets.
AB - Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his compensation using financial markets and shareholders can monitor the manager's portfolio in order to keep him from hedging, but monitoring is costly. We find that the optimal incentive compensation and governance provisions have the following properties: (i) the manager's portfolio is monitored only when the firm performs poorly, (ii) the manager's compensation is more sensitive to firm performance when the cost of monitoring is higher or when hedging markets are more developed, and (iii) conditional on the firm's performance, the manager's compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring. Moreover, the model suggests that the optimal level of portfolio monitoring is higher for managers of firms whose performance can be hedged more easily, such as large firms and firms in more developed financial markets.
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U2 - 10.1162/JEEA.2008.6.1.158
DO - 10.1162/JEEA.2008.6.1.158
M3 - Article
AN - SCOPUS:40249096195
SN - 1542-4766
VL - 6
SP - 158
EP - 209
JO - Journal of the European Economic Association
JF - Journal of the European Economic Association
IS - 1
ER -