Aversion Management Research Articles

Stock-based pay, liquidity, and the role of market making

We study the role of stock market characteristics on managerial compensation. A risk averse manager exerts an unobservable effort that drives future firm value. The value cannot be used in the incentive contract because it realizes in the distant future and compensating the manager cannot be postponed until then. The stock price emerges endogenously because of trading by informed and uninformed traders in a standard competitive noisy rational expectations equilibrium model. We identify new “skin-in-the-game” and “information-overlap” terms in the weights the optimal incentive contract gives to the stock price and to public information. We derive novel comparative statics, e.g., the manager may receive more stock-based pay when traders' information becomes worse. The contract always uses public information except in the special case when uninformed traders are risk-neutral.

Coping with Loss Aversion and Risk Management in the Supply Chain Coordination

In this paper, we apply a combined revenue sharing and buyback contract to investigate the channel coordination of a two-echelon supply chain with a loss-averse retailer. Since loss-averse decision makers usually take on more risks, the Conditional Value-at-Risk (CVaR) measure is introduced to hedge against it and the retailer’s objective is to maximize the CVaR of utility. We obtain the retailer’s optimal order quantity under the combined contract. It is shown that there is a unique wholesale price coordinating the supply chain if the retailer’s confidence level is less than a threshold that is independent of contract parameters. Moreover, a complete sensitivity analysis of parameters is carried out. In particular, the retailer’s optimal order quantity and coordinating wholesale price decreases as the loss aversion or confidence level increases, while it increase as the buyback price or sharing coefficient increases. Furthermore, there exists the situation where the combined contract can coordinate the chain even though neither the revenue sharing nor buyback contract can when the contract parameters are constrained.

Optimal dividend-distribution strategy under ambiguity aversion

This paper considers the optimal dividend policy for an insurance company facing model uncertainty. We provide an explicit solution and show that an increase in ambiguity aversion leads to more conservative dividend policy. Interestingly, we find the ambiguity averse manager exhibits risk loving attitude when the company is close to bankruptcy. Finally, concerns about model misspecification have ambiguous effects on the marginal value of cash, which depends on the cash reserve.

Nonfinancial Performance Measures and Risk Taking: Evidence from the Oil and Gas Industry

This study examines the relation between nonfinancial performance measures (NFPMs) and firms’ risk taking. Specifically, using CEO compensation contracts in the oil and gas industry (SIC 1311), I examine the relation between NFPMs and firms’ exploration and exploitation activities. The oil and gas industry provides an ideal setting for my study because firms in this industry are required to disclose their exploration and exploitation activities, which allows me to develop empirical measures for both activities. I find NFPMs that incentivize high risk exploration activities (exploration NFPM) lead to more investment in exploration activities. More importantly, I find that firms with exploration NFPMs also invest in more low risk exploitation activities and achieve better short-term financial performance compared to other firms. These results are consistent with my hypothesis that explicit incentives to invest in risky projects induce risk averse managers to manage the associated downside risk of failure by allocating resources more efficiently across other projects. My findings shed light on how NFPMs can potentially complement equity-based incentives and financial accounting measures to direct and motivate managers to take on risky projects as well as better manage firm performance.

Stock-Based Pay, Liquidity, and the Role of Market Making

We study the role of stock market characteristics on managerial compensation. A risk averse manager exerts an unobservable effort that drives future firm value. The value cannot be used in the incentive contract because it realizes in the distant future and compensating the manager cannot be postponed until then. Instead, the contract uses the stock price as well as public information about the future value of the firm. The stock price emerges endogenously because of trading by informed and uninformed traders in a standard competitive noisy rational expectations equilibrium model. It is well known that liquidity facilitates trading on private information. We identify a dark side of liquidity for incentive contracting. More liquidity makes the stock price less responsive to trading and hence, less sensitive to the manager's effort. Our model yields novel comparative statics, e.g., the manager may receive more stock-based pay when traders' information becomes worse. The contract always uses public information except in the special case when uninformed traders are risk-neutral.

Research on the Status Quo and Countermeasures of Logistics Terminal Distribution Risk

The occurrence of disputes is an intuitive manifestation of risks. The risk of logistics terminal distribution has been transformed into real disputes and exposed to people's lives. Based on this, the article first analyzes the status quo of logistics terminal distribution, and analyzes the risk status of the typical case of takeaway distribution in the logistics terminal distribution in real life, and classifies its risk into trust, security and economic risk three categories; Secondly, refining the participants involved in the three risks, analyzing the relationship between the participants, and designing the logistics terminal distribution risk aversion management mechanism around the participants' objectives.

Evaluating Sensitivity of the Ranking of Forest Fuel Treatments to Manager’s Risk Attitudes and the Importance of Treatment Objectives, Montana, USA

This study develops a conceptual framework for evaluating the sensitivity of the ranking of forest fuel treatment strategies (FTSs) to variation in managers’ risk attitudes and the importance ratings managers assign to fuel treatment objectives and demonstrates the application of the framework using a case study. The conceptual framework involves (1) defining a utility function on an index that is a weighted average of fuel treatment objectives and incorporates a manager’s risk attitude; (2) using the utility function to calculate utility values for FTSs; (3) applying the stochastic efficiency with respect to a function method to utility values to obtain certainty equivalents (CEs); and (4) ranking FTSs based on statistically significant differences in median CEs for pairs of FTSs. The case study involves three (federal, state, and private) forested areas in Flathead County, Montana, USA, three FTSs (i.e., Community Wildfire Protection Plan (CWPP) Priority; CWPP & Wildland-Urban Interface Priority; and No Priority), three treatment objectives (i.e., minimizing expected residential monetary losses from wildfire, minimizing expected deviation of forest ecological conditions from their historic range and variability, and maximizing expected net returns from timber harvesting associated with fuel treatment), two risk attitudes (i.e., almost risk neutral and highly risk averse), and 35 weight scenarios for treatment objectives. Case study results are used to test the hypothesis that the ranking of FTSs is sensitive to manager’s risk attitudes and the importance ratings for management objectives. The ranking of FTSs for the three forested areas was insensitive for an almost risk neutral manager and sensitive for a highly risk averse manager. In general, the case study indicates that the ranking of FTSs is sensitive to both a forest manager’s risk attitudes and the importance ratings assigned to fuel treatment objectives.

Corporate Social Responsibility and CEO Risk-Taking Incentives

In this paper, we explore how firms adjust CEO compensation incentives in response to corporate social responsibility (CSR) standing. Specifically, we focus on the effect of CSR standing on CEO’s risk-taking incentives. We hypothesize that because firms possessing better social performance generate insurance-like moral capital that protects managers from market discipline, risk averse managers tend to take less risk than is optimal for shareholders. Firms should respond to this agency problem by offering greater risk-taking incentives to managers. Employing a large sample of the US firms from 1992 to 2010, we find strong empirical evidence to support our hypothesis. Indeed, CSR standing is positively related to CEO pay-risk sensitivity (Vega), and this association is driven by CSR strengths rather than CSR concerns. Further, we provide evidence that firm overall risk and idiosyncratic risk negatively moderate the association between CSR and Vega.

Managerial Behavior and Capital Structure Decisions; Do Overconfidence, Optimism and Risk Aversion Matter?

This study aims at examining the importance of managers’ behavior in explaining the capital structure related decisions of the listed firms in the Egyptian stock exchange (EGX). Managers’ behavior data has been collected using a survey method (i.e. psychometric test) which specifies three aspects of the behavior (namely: overconfidence, optimism, and risk aversion) in addition to some demographic characteristics as suggested by previous studies particularly Graham et al. (2013) and Menkhoff et al. (2006). The sample of the study includes 47 mangers and 31 firms along with their related financial information which has been extracted from the published financial statements for a period of 3 consecutive years. The secondary data of the Egyptian firms and the responses from survey were fully analyzed. A cross sectional analysis is applied to assess the effect of the managers’ behavior on the corporate financial leverage level. Further, a hierarchal type of regression is used due to the existence of some control variables. The findings of the study reveal that managerial optimism and risk tolerance have a significant positive impact on the firm's leverage ratio, while managerial overconfidence has no significant impact on the firm's capital structure. Moreover, risk averse managers differ from non-risk averse managers in terms of the adopted leverage level of their firms, as risk averse managers tend to use lower leverage ratio level.

Does Credit Default Swap Initiation Affect Executive Compensation?

In this study, we examine whether the initiation of credit default swaps affects the reference entity’s executive compensation design. With both human capital and financial capital highly associated with the firm’s bankruptcy risk, risk averse managers prefer cash compensation over option compensation to hedge their individual exposure to the firm’s bankruptcy risk. Consistent with this notion, we find a significant increase (decrease) in the proportion of cash (option) compensation around the initiation of CDS trading. Such a finding survives a matching procedure, a falsification test employing a different CDS initiation time and an instrumental variable approach to address the endogeneity. Further, the effect of CDS trading on firms’ compensation design is more pronounced for firms with higher distress risk and for managers who are more powerful.

OPTIMAL INVESTMENT IN HEDGE FUNDS UNDER LOSS AVERSION

We study optimal investment problems in hedge funds for a loss averse manager under the framework of cumulative prospect theory. We obtain explicit solutions for a general utility function satisfying the Inada conditions and a piece-wise exponential utility function. Through a sensitivity analysis, we find that the manager reduces the risk of the hedge fund when her/his loss aversion, risk aversion, ownership in the fund, or management fee ratio increases. However, the increase of incentive fee ratio drives the manager to seek more risk in order to achieve higher prospect utility.

Levels of Anxiety and Salivary Alpha-Amylase in Children During Restorative Dental Treatment

Objective: To assess levels of anxiety and salivary alpha-amylase in children and its association with the use of informative or aversive behavioral management techniques during restorative dental procedures. Material and Methods: A cross-sectional study was performed with 69 children aged 4-12 years submitted to restorative dental treatment. The level of anxiety of patients was verified by means of the Modified Venham Picture Test and levels of salivary alpha-amylase were measured before and after the restorative procedure. The behavioral management techniques used during the dental procedure were registered. Associations between variables were analyzed using the chi-square test, considering statistically significant associations with p ≤ 0.05. Results: Salivary alpha-amylase showed high and moderate levels prior to dental procedure in 47 children (68.1%). Variables gender and behavioral management techniques were not associated with anxiety, as measured by VPT and salivary alpha-amylase activity. However, younger children showed higher levels of alpha-amylase (p = 0.001). Conclusion: The sample revealed that the visit to the dentist has generated anxiety, manifested by behavioral and physiological changes, especially in children under 72 months; thus, no association between anxiety and the different management techniques was observed.

CEO Severance Pay and Corporate Tax Avoidance

We examine the association between CEO severance pay (i.e., payment the CEO would receive if s/he is involuntarily terminated) and corporate tax avoidance. We find that corporate tax avoidance is increasing in the amount of CEO severance pay. This finding is consistent with the notion that CEO severance pay encourages otherwise risk averse managers to take reasonable amounts of risk and, thus, fits into the optimal executive incentive scheme as a form of efficient contracting. Further analysis reveals that the association between CEO severance pay and corporate tax avoidance is stronger in situations where we expect the risk-taking incentives provided by severance pay to matter more – when the CEO is otherwise more risk averse and when firms exhibit a higher business risk. Overall, our findings suggest that firms can contract with their managers using CEO severance pay to provide incentives for them to engage in tax avoidance activities.

Risk aversion, prudence, and compensation

In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function u who are risk averse (u″<0) and prudent (u″′>0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, managerial prudence can contribute to explain the prevalence of stock-options in executive compensation. However, convex contracts are not optimal when the principal is sufficiently prudent relative to the manager.

The valence of the long-lasting emotional experiences with various handlers modulates discrimination and generalization of individual humans in sheep1

Between-farm variation in animal reactions to humans can reflect different management styles and behavioral tendencies among farmers. Animals are well known to discriminate among humans, but less clear is the key issue of whether they more or less easily generalize their experience from specific humans to others depending on management style. Here, we chose 2 contrasted management styles by known handlers: "gentle" management, that is, long-lasting exposure to positive human interactions (with limited negative interactions), and "aversive" management including long-lasting exposure to various negative human interactions (with only food delivery considered a positive interaction) and aversive events. Over a period of 19 wk, 15 female lambs were exposed to the gentle management treatment ("gently treated" group) and another 15 lambs ("aversively treated" group) were exposed to the aversive management treatment. To facilitate discrimination by animals, experimenters wore white clothes for aversive events and green clothes for farming handling (positive handling and feeding for the gently treated group and only feeding for the aversively treated group). Sheep perception of the human was assessed after the management period by submitting lambs from each group to 2 standardized tests: 1) the presence of a stationary human (familiar human in white vs. familiar human in green vs. unknown human) and 2) the presence of a moving human (familiar human in white vs. familiar human in green vs. unknown human). As expected, during the stationary human test, aversively treated lambs spent less time in the human zone (P<0.0001), showed greater latency to approach the human (P=0.05), and had fewer contacts with the human (P=0.05) than gently treated lambs. During the moving human test, aversively treated lambs also showed a greater escape distance from humans than gently treated lambs (P<0.0001). Aversively treated lambs showed the same fear responses towards familiar and unknown humans and tended to generalize their aversive experiences with one handler to all humans. In contrast, gently treated lambs seemed to discriminate familiar humans from unfamiliar humans. Different management styles could modulate farm generalization to humans in farm animals.

The separation of ownership and control and corporate tax avoidance

We examine whether variation in the separation of ownership and control influences the tax practices of private firms with different ownership structures. Fama and Jensen (1983) assert that when equity ownership and corporate decision-making are concentrated in just a small number of decision-makers, these owner-managers will likely be more risk averse and thus less willing to invest in risky projects. Because tax avoidance is a risky activity that can impose significant costs on a firm, we predict that firms with greater concentrations of ownership and control, and thus more risk averse managers, avoid less income tax than firms with less concentrated ownership and control. Our results are consistent with these expectations. However, we also consider a competing explanation for these findings. In particular, we examine whether certain private firms enjoy lower marginal costs of tax planning, which facilitate greater income tax avoidance. Our results are consistent with the marginal costs of tax avoidance and the separation of ownership and control both influencing corporate tax practices.

The Role of Transitory Earnings for Managerial Effort Allocation to Intangibles

There is a concern about the ability of earnings to adequately reflect managerial efforts to intangible-based activities. Agency theory suggests that when core earnings relay little information about managerial effort to certain activities, effort allocation will be insufficient. Risk averse managers consider costs of investing in RD they can send signals about the future and security prices reflect information about them. This means that even though the accounting system creates weak value relevant core earnings concerning intangibles, if transitory earnings can provide some additional information, they can play a vital incentive role. For example, unsuccessful prior intangible investments or obsolete inventory would be reported as transitory earnings (e.g., disposal of a poorly performing line of operation, asset write-downs, inventory write-offs), which can send signals to markets about managerial effort to tackle problems. These can be useful to convey information about managerial efforts exerted on intangibles. I show that under these conditions, market-based compensation helps to mitigate inefficient effort allocation to intangible-based activities. However, the reflection of transitory earnings in market-based compensation can also encourage earnings management. Managers may allocate their effort to a nonproductive activity such as shifting operating expenses to non-operation expenses to avoid a sharp decline in security price or/and meet analyst forecasts. Such activities do not increase economic value. Thus, the ability of transitory earnings to produce proper managerial effort allocation has to be weighed against the possibility of encouraging earnings manipulation.

Optimal Contracts and Organization of Multiple Money Managers

The optimal organizational form and contracts are characterized for multiple money managers whose actions affect both expected returns and correlation of returns. Inducing diversification of effort to lower risk is in conflict with transfering risk to managers. Encouraging competition is the optimal way to induce risk-tolerant managers to exert effort in diversified activities. As risk aversion increases, enabling cooperation becomes optimal. Counterintuitively, a contract that encourages effort diversification transfers more risk to managers with higher risk aversion. There is a clientele effect: well designed contracts induce more and less risk averse managers to separate in their choices of employment.

The Effect of Risk Preferences on the Valuation and Incentives of Compensation Contracts

In a standard principal-agent setting, we use a comparative approach to study the incentives provided by different types of compensation contracts, and their valuation by managers with utility function u who are risk averse (u'' 0). We show that concave contracts tend to provide more incentives to risk averse managers, while convex contracts tend to be more valued by prudent managers. This is because concave contracts concentrate incentives where the marginal utility of risk averse managers is highest, while convex contracts protect against downside risk. Thus, managerial prudence can contribute to explain the prevalence of stock-options in executive compensation. However, convex contracts are not optimal when the principal is sufficiently prudent relative to the manager.

The Wage Schedule of a Risk Averse Manager in an Insurance Market

The Wage Schedule of a Risk Averse Manager in an Insurance Market