Risk-taking Decisions Research Articles

Risk-taking Factors in a Dynamic Approach

The most common definition of risk is quantified by the probability of an adverse event occurring and the value of the adverse consequence. Theoretically, the decision to take a risk can also be based essentially on these two pieces of information. In addition, according to traditional risk-taking models, the perception of risk, the psychological characteristics of the decision-makers and their relevant experience are also important. In the case of mathematical-statistical-psychological models, little emphasis is placed on the fact that risk is in fact the inability to completely control the activity in question. The causes of this incompleteness are based on the shortcomings in the relevant capabilities of the economic agent. Economic agents have different capabilities, so they rarely face the same risks, even for almost identical activities. Just as the requirements and circumstances of the activity are constantly changing, so are the capabilities of the economic agent. Consequently, the size of the capability gap of an economic agent is also constantly changing. This should be taken into account in risk-taking decisions and their revision. The paper attempts to model this dynamic risk-taking mechanism and to show how different risk-taking strategies may be pursued by economic agents in certain baseline situations.

Enterprise risk management, corporate governance and insurers risk-taking behaviour in South Africa: evidence from a linear and threshold analysis

PurposeThis study examines the linear and non-linear effects of enterprise risk management (ERM) and corporate governance (CG) on insurers’ risk-taking behaviour.Design/methodology/approachThe study employed panel data of 63 insurers from South Africa over the period 2015 and 2019. The study used the generalised method of moments (GMM) to determine the direct relationship, while the dynamic panel threshold technique was utilised to discover whether there is non-linearity in the relationship and the threshold level at which ERM and CG stimulate insurance risk-taking.FindingsThe result from the GMM elicits a positive relationship between ERM and risk-taking, implying that insurers with a robust ERM system are more likely to pursue higher risks. The empirical evidence also suggests that board size and board independence improve insurers’ risk-taking. Contrarily, gender diversity shows an inverse relationship with risk-taking. The dynamic panel threshold regression confirms non-linearities between ERM, CG and risk-taking. The empirical evidence indicates a U-shaped relationship between ERM and risk-taking, implying that a robust ERM system increases insurers’ risk-taking and vice-versa. Further, board size and independence reveal an inverted U-shaped relationship, suggesting that larger boards and a higher proportion of independent directors exhibit lower risk-taking. However, gender diversity presents a negative relationship, demonstrating a strong impact at higher threshold levels. This tells that the presence of females on the board reduces insurers’ risk-taking preferences.Practical implicationsDue to the risk-bearing nature of the insurance business, it is required that they ensure a robust ERM system for prudent risk-taking decisions. This demands strict adherence to ERM principles and allocating sufficient resources for effective implementation. Also, there is a need for strong CG structures that pay more attention to diversity when selecting board members due to their influence in ensuring improved risk-taking choices.Originality/valueThis study contributes to the existing literature by providing insights into the under-researched role of ERM and CG in insurers’ risk-taking behaviour. The study further extends the literature by providing evidence on the non-linearity and threshold levels at which ERM and CG influence insurers’ risk-taking choices. The findings are unique and contribute to the growing body of literature documenting the need for strong ERM and CG systems in insurance companies.

Economic uncertainty, risk-taking incentives and production management

PurposeThis study aims to validate the link between production manipulation and a firm’s performance variability (fundamentals and stock returns). It explores whether executives' risk-taking incentives encourage production deviations around the normal level during uncertainty.Design/methodology/approachUtilizing panel data of manufacturing firms from Compustat over three decades, the study investigates production management practices during economic uncertainty. The Economic Policy Uncertainty Index (EPU) is employed as a key metric. The empirical strategy involves documenting the effect of economic uncertainty on overproduction and underproduction, examining the role of executive compensation and assessing the impact on risk.FindingsThe research finds that risk-taking incentives increase over/underproduction, particularly amplifying the extent of underproduction during uncertainty. Production deviation rises, indicating that firms take greater risk by engaging in abnormal business operations. The study’s results are robust against various econometric methods, emphasizing the influence of risk-taking incentives on corporate production decisions.Research limitations/implicationsWhile providing valuable insights, the study acknowledges inherent limitations, including factors influencing production decisions beyond risk-taking incentives. Further research could explore additional determinants for a comprehensive understanding.Practical implicationsThe findings highlight the potential dark side of executive compensation that motivates suboptimal risk-taking decisions, impacting risk, cost of capital and firm performance. Policymakers and compensation committees can use these insights to design efficient systems that mitigate moral hazard problems associated with productivity changes.Social implicationsThe study emphasizes the broader social implications of production manipulation under uncertainty. It prompts discussions on the ethical considerations of managerial opportunism, its potential consequences for stakeholders and market dynamics.Originality/valueThis study contributes to the literature by examining the role of economic uncertainty on production manipulation and the influence of risk-taking incentives. It extends the earnings management literature by considering real activity manipulation and emphasizing the importance of decomposing production deviation into positive and negative values.

Skill, effort, luck: Determinants of rank-based endowments and risk-taking in a social setting

Social comparisons and rank-based endowments impact risk-taking decisions. We provide experimental evidence indicating that rank-based endowments have differential impacts on risk-taking decisions based on the aspect used to rank individuals. We observe the largest rank-based differences when such endowments are determined based on individuals’ effort or skill. Compared to individuals who rank first, individuals who rank last in these settings increase their risk-taking by, on average, 17.55 percentage points (pp). In the case of luck-based endowments, the effect size is significantly smaller (11.34 pp). We conduct an additional treatment where rank and endowment are independent and find that differences in risk-taking are driven mainly by participants’ endowments rather than by the ranking itself.

Do you have a choice?: Implications for belief updating and the disposition effect

The present paper evaluates the importance of belief updating for the prevalence of the disposition effect – the reluctance to sell assets at losses as compared to gains. In particular, the present paper studies whether restricting choices in investment risk taking decisions motivates different learning from the decision outcomes and whether such differences in learning cause differences in the emergence of the disposition effect. The results show that investors learn from negative outcomes more like Bayesians if their risk-taking decisions are restricted. Causal mediation analysis reveals that such differences in learning increases the probability to sell after losses, which improves the overall investment performance. Compared to gains, the differences in learning after losses explain also why investors making active risk-taking choices are less likely to sell after losses as compared to gains, while the effect is reversed when choices are restricted. These findings suggest that restricting the discretion in decisions influences the way investors learn from decision outcomes and these differences in learning can explain puzzling differences in the risk-taking behavior of individual investors.

Balancing risk-return decisions by manipulating the mesofrontal circuits in primates.

Decision-making is always coupled with some level of risk, with more pathological forms of risk-taking decisions manifesting as gambling disorders. In macaque monkeys trained in a high risk-high return (HH) versus low risk-low return (LL) choice task, we found that the reversible pharmacological inactivation of ventral Brodmann area 6 (area 6V) impaired the risk dependency of decision-making. Selective optogenetic activation of the mesofrontal pathway from the ventral tegmental area (VTA) to the ventral aspect of 6V resulted in stronger preference for HH, whereas activation of the pathway from the VTA to the dorsal aspect of 6V led to LL preference. Finally, computational decoding captured the modulations of behavioral preference. Our results suggest that VTA inputs to area 6V determine the decision balance between HH and LL.

The influence from the past: Successors’ overseas growth experiences and corporate risk-taking

This study explores the effect of the overseas growth experiences of successors in family businesses on corporate risk-taking. We theorize that successors in family businesses, influenced by psychological characteristics imprinted during their overseas experiences, are more inclined to undertake risky strategic decisions. However, due to considerations related to social emotional wealth, family businesses may intervene in the successors? risk-taking decisions. Therefore, family control may positively or negatively moderate the relationship between successors? overseas growth experiences and corporate risk-taking. Our theoretical expectations are tested using a matched sample of Chinese-listed family firms from 2012 to 2021. With supportive empirical results, we contribute to the literature on risk-taking by exploring the predecessors of corporate risk-taking and enriching SEW theory by bringing in the insights of imprinting theory.

Do peer effects matter in bank risk? Some cross-country evidence

This paper empirically investigates whether peer effects play a significant role in shaping banks’ risk. We use panel data from more than 550 public banks in 32 economies during the period of 2000––2018. By estimating the directional pairwise connectedness between banks to identify the heterogeneous influence that peers may exert to banks’ performance, we find supportive evidence that banks’ risk is positively associated with that of their peers. This finding is consistent with the hypothesis that banks may learn from their peers when making their own risk-taking decisions. Our result remains consistent when we use various approaches to mitigate the potential endogeneity problems, employ various indicators of bank risk, and exercise some other robustness checks. Furthermore, our findings reveal that peer effects exhibit variations in response to some specific bank characteristics and market conditions.

Delegated risk-taking, accountability, and outcome bias

In a sequence of experiments, this study investigates how people evaluate others who make risky decisions on their behalf, and how such evaluations affect delegated risk-taking. A decision maker acts on behalf of a client who holds the decision maker accountable by way of a subjective evaluation after observing a risky decision’s outcome. If evaluation is biased towards the outcome, it may have dysfunctional effects with respect to delegated risk-taking in that decision makers’ risk choices are increasingly misaligned with their clients’ risk preferences. We find evidence giving support to this conjecture. Across and within three experiments, we test for the effects of different types and degrees of accountability in that we manipulate the information available to clients as well as the consequences which evaluations have for decision makers. Evaluations are biased towards outcomes in all experiments. When evaluations affect decision maker’s compensations, a stronger outcome bias in evaluations translates into risk-taking decisions being less frequently aligned with clients’ risk preferences. In the same situation, giving clients the opportunity to make peer comparisons increases outcome bias. We further find that clients do not hold decision makers accountable for their risk choices when they cannot observe the risk-taking decision, but have to infer it from observing the outcome. Theoretical and practical implications of the results are discussed.

Talent, basic research and growth

Due to the public good nature of basic research, the mechanisms for rewarding talent are very different from those prevailing in the production of applied research by private actors. We develop a growth model in which such mechanisms are taken explicitly into account. This allows us to address the following fundamental questions: how do policies in the public research sector influence the effort and risk-taking decisions of researchers of different talent? How do these choices affect the aggregate production of basic research? What is the final impact on growth? The analysis shows that the design of research evaluation policies crucially affects both the long run rate of growth and the relationship between taxation and growth. A key and novel channel through which this occurs is the effect of basic research policy on the expected non-monetary benefits from being a researcher.

P2P lending: Moderation of desirability of control on risk-taking decisions of Indonesian borrowers

The number of users of peer-to-peer (P2P) lending applications in Indonesia continues to grow rapidly even though it is followed by increased cases of alleged criminal violations in the financial sector. Users continue to use these financial technologies despite being aware of the high risks and potential negative consequences they may receive. Meanwhile, the results of previous research in the context of financial technology show that the higher the risk perceived by users, the more discouraged they are from using financial technology. In addition, the number of studies that discuss decision-making at the user group level is still limited. Tests using the structural equation model (SEM) method showed that the desirability of control moderates the negative effect of perceived risk on P2P lending usage intention. The desirability of control is proven to weaken the effect of perceived risk on the intention to use P2P lending. As a result, borrowers with high desirability of control tend to ignore the high risk of using online lending providers so they will continue to take these actions. Meanwhile, borrowers with low desirability of control try to maintain their control by avoiding the use of P2P lending. In addition, the Bollen–Stine bootstrap procedure also showed that the model meets the goodness of fit even though the data was not normally distributed in multivariate analysis. The results of this study also imply that the government needs to formulate regulations to tighten lending procedures to minimize the potential for defaults on debt that harm the community and online lending providers.

The Role of Non-Managerial Inside Debt in Firm Risk and the Cost of Debt

ABSTRACT This study investigates the impact of non-managerial inside debt on managerial risk-taking decisions and the cost of debt. We propose a theoretical model demonstrating that non-managerial inside debt can reduce firm risk by influencing managers’ risk-taking decisions and that non-managerial inside debt is inversely related to the firm’s cost of debt. From the proposed model, we develop an empirical hypothesis that indicates the negative relationship between non-managerial inside debt and the cost of debt. We test the hypothesis empirically and find evidence to support the model. The paper adds a novel theoretical model to the literature that shows the significance of non-managerial inside debt in firm risk-taking and capital raising.

The soft landing: Does intrafamily succession matter for corporate risk-taking?

Succession has been recognized as one key challenge to family firms. To manage succession risks, founders aiming for intrafamily succession might adopt risk-averse strategies in advance. Using a sample of A-share listed family firms in China, we find that family firms with apparent family successors are indeed more risk-averse than those without such successors: the former group has fewer investments in research and development (R&D), lower debt, more cash holdings, and less volatile earnings than the latter. These effects are weaker for firms in a more market-oriented environment, firms with stronger family control, or firms faced with more intense market competition. Further analyses show that the reduced risk-taking for intrafamily succession is stronger when successors have been involved in family businesses. Firms with male successors are also more risk-averse than those with female successors except in R&D investments. By illustrating that founders proactively curb firm risks to increase risk capacity for family successors, this paper not only contributes to the literature on family succession, but also extends the literature about determinants of corporate risk-taking decisions.

Labor Unemployment Risk and CEO Incentive Compensation

Unemployment risk influences workers’ incentives to invest in firm-specific human capital. This paper investigates the impact of unemployment risk on chief executive officers (CEOs)’ risk-taking incentive compensation. Exploiting state-level changes in unemployment benefits, we find that after unemployment insurance benefits become more generous, boards increase the convex payoff structure of CEO pay to encourage risk taking. The increase in CEOs’ convexity payoff is stronger in firms with more independent and diverse boards, higher ownership of long-term shareholders, and in industries requiring highly skilled labor. Our findings suggest that boards internalize workers’ interests in firms’ risk-taking decisions and executive compensation is one mechanism used. This paper was accepted by David Simchi-Levi, finance. Funding: K. Zhang acknowledges financial support from the National Natural Science Foundation of China [Grants 72272099 and 71902115]. Supplemental Material: Data and the online appendix are available at https://doi.org/10.1287/mnsc.2023.4714 .

EVALUATION OF DIFFERENCES IN PERFORMANCE BETWEEN SHAREHOLDER-CEO-LED AND PROFESSIONAL-CEO-LED LARGE COMPANIES IN LITHUANIA

There is an ongoing debate on what exactly are the differences between founder/shareholder-CEOs and professional-CEOs, and how those differences impact the performance of companies both from a managerial and financial standpoint. Though this issue attracted a lot of attention from scholars during the last 30 years, and the consensus has formed that there are indeed differences in motivational factors, managerial capabilities as well as risk-taking decisions between founder/shareholder-CEOs and professional-CEOs, the research on how this impacts firm performance provides inconsistent results. This paper aims to add to existing research in the field by evaluating whether there are significant differences in revenue growth rates and profitability between founder/shareholder-CEO-led and professional-CEO-led companies. Based on the revenue and profit data for the 5-year period of 2016 to 2020 of a sample of 205 of the largest companies in Lithuania, no significant differences in performance were identified. In this sense, this study confirms the generalization that the influence of a CEO diminishes as ventures grow and mature.

Does firm competitiveness affect corporate risk-taking?

PurposeFew studies utilize insurance sector data to analyze how insurers' competitiveness affects their risk-taking decisions. To fill the research gap, this study aims to investigate the relationship between insurers’ competitiveness and risk-taking decisions.Design/methodology/approachThis study employs unbalanced panel data for the US property-liability insurance companies from 2006 to 2019. Two-Stage estimation is applied to address the endogeneity issue, such as the Two-Step Generalized Method of Moments, General Two-Stage Least Square and Two-Stage Quantile Regression.FindingsThe regression analysis reveals that insurers' competitiveness in their risk-taking decisions is primarily negative. The finding suggests that insurers with low (high) competitiveness tend to take more (less) risk. This study sheds light on how insurers with low competitiveness may alter their risk preference, supporting the fundamental argument of the prospect theory, the CEO hubris argument, the risk-return theory and the risk-sensitivity theory.Research limitations/implicationsThe critical findings of this study provide policy implications when evaluating and drafting insurance legislation. Regulators must pay close attention to insurers' riskier decisions while insurers with low competitiveness or during periods of economic recession.Originality/valueThis research contributes to the literature by assessing whether insurers' competitiveness influences their risk-taking decisions. The empirical findings suggest that insurers with low competitiveness take on greater risks to gamble for survivability and boost profits to strengthen their financial standing. The evidence indicates that insurers may risk-seeking or irrational decision-making when facing a competitive disadvantage.

The risk-taking behavioural intentions of pilots in adverse weather conditions: an application of the theory of planned behaviour

This paper examined pilots’ risk-taking behavioural intentions based on the theory of planned behaviour, as well as the impact of experience on behavioural intentions in adverse weather conditions. Two hundred and seventy-three airline pilots and flying cadets were divided into two groups and asked to complete a questionnaire based on two decision-making scenarios. This questionnaire measured pilots’ intentions to take risks, along with the attitude towards the behaviour, subjective norms, perceived behavioural control (PBC), risk perception, and self-identity. The results showed that attitude, subjective norm, PBC, and risk perception explained 52% of the variance in behavioural intentions. Additionally, pilots’ risk-taking decisions can be influenced by experience. Inexperienced pilots had a relatively stronger intention to take risks and a more favourable attitude towards risky behaviour. Moreover, pilots were more likely to rely on their own direct experience in the decision-making process. Practitioner summary: This study examined the pilots’ risk-taking intentions under adverse weather conditions using a questionnaire based on the TPB theory. Results demonstrated that the TPB model can be applied to the risk-taking scenario and that experience can influence pilots’ decisions. These findings have implications for improving flight safety and lowering accident rates.

The neural correlates underlying the regulation of anticipation on regret

Regret is a common negative emotion in daily life, and long-term immersion in regret affects mental health. Therefore, to regulate and reduce regret is of wide concern. The current fMRI study aimed to investigate whether outcome anticipation before decision-making could reduce regret and its neural correlates. In the task, participants were asked to anticipate the possible poor outcomes of subsequent decisions, such as missing rewards and meeting punishment, and then made sequential risk-taking decisions. Behavioral results showed that outcome anticipation before decision-making could decrease the intensity of regret, that is, participants felt less regret when they anticipated the outcome before decision-making (anticipation condition, Ant), compared to making sequential risk-taking decisions without any anticipation of the outcome in advance (non-anticipation condition, NAnt). Consistently, at the neural level, stronger activities of ventral striatum (VS) and dorsal medial prefrontal cortex (dmPFC), and greater VS-dmPFC functional connectivity were observed in Ant relative to NAnt. Moreover, the activity of dmPFC was negatively correlated with the intensity of regret in Ant. The current study highlighted that outcome anticipation before decision-making could regulate regret effectively, and dmPFC played a vital role in this process.

The Two Blades of the Scissors: Performance Feedback and Intrinsic Attributes in Organizational Risk Taking

We draw on the behavioral theory of the firm and prospect theory to examine how performance feedback (decision context) and the characteristics of the alternatives (decision content) that decision makers face jointly determine organizational risk-taking choices. While the behavioral theory of the firm has identified performance feedback’s important role in driving organizational risk-taking decisions, it has not considered the intrinsic attributes of alternatives, specifically the magnitude and likelihood of their outcomes, which have been the focus of prospect theory. We argue that these two attributes play a key role in decision makers’ assessment of alternatives, but because achieving organizational goals is the prime objective in organizations, performance feedback drives how decision makers process information regarding these attributes. Analyzing 23,895 fourth-down decisions from the U.S. National Football League, we find that decision makers weigh attainment discrepancy and the magnitude and likelihood of outcomes in their choices, depending on deadline proximity. Furthermore, the size and valence of attainment discrepancy modify the weight of the magnitude and likelihood of outcomes in risky choices. Our arguments and findings suggest extensions to the behavioral theory of the firm and imply modifications to prospect theory when applied to the organizational context.

Household Portfolio Allocations: Evidence on Risk Preferences from the Household, Income, and Labour Dynamics in Australia (HILDA) Survey Using Tobit Models

This study investigates intrahousehold risk preferences in household portfolio decision-making. Most household finance data are collected at the household level, and it is challenging to come up with an explanation of risk-taking decisions and have a direction on the within-household bargaining mechanisms. We provide these challenging pieces of evidence by applying a Tobit model on panel data taken from waves 2 to 6 of HILDA surveys. Overall, the results indicate that the risk-taking attitude of partners matters in household portfolio allocations. Risk-averse males and their female counterparts invest less in risky assets. Compared with the no-conflict (identical risk preferences) group, male partners with risk-loving behaviour tend to invest more in risky assets. Further, individual risk preferences are sensitive to fluctuations in equity and housing markets in Australia. Taken together, one of the crucial implications of our findings for future research is that household-bargaining models should, perhaps, give more bargaining power to risk-loving males, offering an additional explanation for the determinants of risk-taking behaviour of households. Understanding the risk-taking attitudes of households is important for future work to understand the fraction of households that end up with a negative net worth in recessions or crisis conditions, such as financial crises, pandemics, and wars.