Bowman's risk-return paradox: An agency theory perspective

Abstract

The negative association between risk and return is paradoxical because risk-averse managers should only expose themselves to higher risk for higher returns. The paradox is resolved, however, if we recognize that risk-averse managers may be taking decisions that pose risk for shareholders and not for their own careers. We draw on the career concerns literature to explain why decisions that pose risk to shareholder returns can enhance managerial careers. We provide evidence that the risk-return paradox is exacerbated by agency problems that contribute to career concerns (i.e., CEO career horizon), and mitigated by various governance mechanisms that curb the agency problem by aligning managers with shareholders (such as monitoring by the market for corporate control, large block owners, institutional owners, vigilant board, and CEO incentive alignment). Our study sheds light on the role of career concerns and corporate governance in resolving the risk-return paradox.