The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation

Rajesh Aggarwal, Andrew A. Samwick

NBER Working Paper No. 6634
Issued in July 1998
NBER Program(s):Asset Pricing, Corporate Finance, Labor Studies

The principal-agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance, yet the existing empirical evidence supporting it is quite weak. The key predication of the model is that the executive's pay-performance sensitivity is decreasing in the variance of the firm's performance. We demonstrate strong empirical confirmation of this prediction using a comprehensive sample of executives at large corporations. In general, the pay-performance sensitivity for executives at firms with the least volatile stock prices is an order of magnitude greater than the pay-performance sensitivity for executives at firms with the most volatile stock prices. This result holds for both chief executive officers and for other highly compensated executives. We further show that estimates of the pay-performance sensitivity that do not explicitly account for the effect of the variance of firm performance are biased toward zero. We also test for relative performance evaluation of executives against the performance of other firms. We find little support for the relative performance evaluation model. Our findings suggest that executive compensation contracts incorporate the benefits of risk-sharing but do not incorporate the potential informational advantages of relative performance evaluation.

download in pdf format
   (197 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w6634

Published: Journal of Political Economy, Vol. 107 (February 1999): 65-105. citation courtesy of

Users who downloaded this paper also downloaded* these:
Bebchuk, Fried, and Walker w9068 Managerial Power and Rent Extraction in the Design of Executive Compensation
Aggarwal and Samwick w5648 Executive Compensation, Strategic Competition, and Relative Performance Evaluation: Theory and Evidence
Baker and Hall w6868 CEO Incentives and Firm Size
Hall and Liebman w6213 Are CEOs Really Paid Like Bureaucrats?
Barro and Barro w3262 Pay, Performance, and Turnover of Bank CEOs
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us