corporate conservatism and relative compensation this paper demonstrates that in a simple setting with managerial concern for reputation and asymmetric information on ability most managers may refrain from undertaking innovations that stochastically dominate an industry standard common components of uncertainty lead to market inferences of managerial ability based on relative performance managers who undertake the industry standard are consequently evaluated with a more accurate benchmark than those innovating discontinuities in compensation when performance is low because of firings lead managers to have differing valuations of an accurate benchmark depending on type in particular very high and very low ability managers are more likely to undertake superior innovations than those of average ability

evidence on corporate hedging policy this paper provides empirical evidence on the determinants of corporate hedging decisions the paper examines the evidence in light of currently mandated financial reporting require ments and in particular the constraints placed on anticipatory hedging data on hedging are obtained from 1992 annual reports for a sample of 3 022 firms out of the 771 firms classified as hedgers 543 firms disclose information in their annual reports on their hedging activities the remaining 228 firms report use of derivatives but no information on hedging activities based on the evidence i draw the following conclusions with respect to the models of hedging evidence is inconsistent with financial distress cost models evidence is mixed with respect to contracting cost capital market imperfections and tax based models and evidence uniformly supports the hypothesis that hedging activities exhibit economies of scale

ceo risk preferences and hedging decisions a multiyear analysis abstract theory and previous empirical studies suggest that ceo risk preferences affect hedging we challenge this idea in a 5 year time series setting by using inside debt i e ceo pension and deferred compensation and the ceo vega and ceo delta as proxies of ceo risk preferences and document that neither risk averse i e debt like compensation nor risk seeking i e convex compensation inducing ceo compensation packages influence corporate hedging moreover we find ceos who have more previous work experience and high job tenure to be positively related to hedging

empirical evidence on the relation between stock option compensation and risk taking abstract we examine whether executive stock options esos provide managers with incentives to invest in risky projects for a sample of oil and gas producers we examine whether the coefficient of variation of future cash flows from exploration activity our proxy for exploration risk increases with the sensitivity of the value of the ceo s options to stock return volatility eso risk incentives both eso risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach we find evidence that eso risk incentives has a positive relation with future exploration risk taking additional tests indicate that eso risk incentives exhibits a negative relation with oil price hedging in a system of equations where eso risk incentives and hedging are allowed to be endogenously determined overall our results are consistent with esos providing managers with incentives to mitigate risk related incentive problems

challenges for wholesale electricity markets with intermittent renewable generation at scale the us experience the supply of intermittent wind and solar generation with zero marginal operating cost is increasingly rapidly in the us these changes are creating challenges for wholesale markets in two dimensions short term energy and ancillary services markets built upon mid twentieth century models of optimal pricing and investment which now work reasonably well must accommodate the supply variability and energy market price impacts associated with intermittent generation at scale these developments raise more profound questions about whether the current market designs can be adapted to provide good long term price signals to support investment in an efficient portfolio of generating capacity and storage consistent with public policy goals the recent experience of the california iso caiso is used to illustrate the impact of intermittent generation on supply patterns supply variability and market based energy prices reforms in capacity markets and scarcity pricing mechanisms are needed if policy makers seek to adapt the traditional wholesale market designs to accommodate intermittent generation at scale however if the rapid growth of integrated resource planning subsidies for some technologies but not others mandated long term contracts and other expansions of state regulation continue more fundamental changes are likely to be required in the institutions that determine generator and storage entry and exit decisions

does executive portfolio structure affect risk management ceo risk taking incentives and corporate derivatives usage abstract this paper extends the investigation of the effect of managerial motives on hedging policy i utilize a proxy variable that incorporates ceo incentives to increase risk relative to incentives to increase stock price the variable is directly measured using observed characteristics of ceo portfolios of stock and option holdings furthermore ceo risk taking incentives are modeled as a choice variable to eliminate the simultaneity bias of modeling risk taking incentives as an exogenous variable if modeled as a simultaneous system of equations a strong negative link between ceo risk taking incentives and the amount of derivative holdings exists this result is consistent with the notion that derivatives are used for hedging purposes both the characteristics of stock and option holdings are important in determining cross sectional differences in corporate derivative holdings

exchange rate hedging financial versus operational strategies exchange rate exposure is an important source of risk for multinational corporations to mitigate the impact of exchange rate fluctuations it has been claimed that multinational corporations can employ risk management strategies not only through financial derivatives but also through operational hedges for example schering plough in its 1995 annual report p 25 argues in support of exclusive use of operational hedges to date management has not deemed it cost effective to engage in a formula based program of hedging the profitability of these operations using derivative financial instruments some of the reasons for this conclusion are the company operates in a large number of foreign countries the currencies of these countries generally do not move in the same direction at the same time conversely many corporations with large worldwide networks such as ibm or coca cola make extensive use of derivative financial instruments this paper investigates both financial and operational exchange rate risk management strategies of multinational firms while several studies have examined either firms financial hedging or firms operational hedging activities no study thus far has examined financial and operational hedging simultaneously for a large cross section of firms to the extent that the decision to use financial hedging strategies is related to and affected by the operational strategies that a firm employs it is important to examine how each strategy contributes to the overall goal of mitigating risk and improving shareholder value using a sample of u s multinational nonfinancial firms during 1996 1998 we find that operational hedging is not an effective substitute for financial risk management however we find that the more geographically dispersed a firm is the more likely it is to use financial hedges the end result on firm value is that operational hedging strategies benefit shareholders only when used in combination with financial hedging strategies

managerial incentive problems a dynamic perspective the paper studies how a person s concern for a future career may influence his or her incentives to put in effort or make decisions on the job in the model the person s productive abilities are revealed over time through observations of performance there are no explicit output contingent contracts but since the wage in each period is based on expected output and expected output depends on assessed ability an implicit contract links today s performance to future wages an incentive problem arises from the person s ability and desire to influence the learning process and therefore the wage process by taking unobserved actions that affect today s performance the fundamental incongruity in preferences is between the individual s concern for human capital returns and the firm s concern for financial returns the two need be only weakly related it is shown that career motives can be beneficial as well as detrimental depending on how well the two kinds of capital returns are aligned it is well understood by now that informational externalities may place special demands on the organization of economic exchange simple price mediated markets will frequently fail in the presence of asymmetric information in that case more elaborate contractual arrangements have to be used as substitutes for the price system lately considerable effort has been devoted to the analysis of contracting under incomplete information with the objective to understand the range of economic institutions that emerge in response to the failure of the price system the analysis of moral hazard has played a prominent role in this development moral hazard problems arise when for some reason or another transacting parties cannot contract contingent on the delivery of the good for instance in buying labour services it may be that the amount of labour supplied is not directly observable precluding a simple exchange of wage for labour as a partial remedy to this problem an imperfect mutually observed signal about the supply of labour can be used as a proxy in the contract frequently output is taken as such a proxy the drawback is that output is often influenced by other factors than labour input which induce undesirable risk into the contract one is therefore faced with a tradeoff between allocating risk associated with incomplete observability and providing incentives for a proper supply of labour gaining insight into this tradeoff is important not only for understanding contracting in the small e g managerial incentive schemes but also because it is closely related to the fundamental tension between equity and efficiency in the society as a whole while our understanding of moral hazard has advanced a lot in past years it is clear that much work remains an important question that has received little attention until

the volatility and price sensitivities of managerial stock option portfolios and corporate hedging we use estimates of the black scholes sensitivity of managers stock option portfolios to stock return volatility and the sensitivity of managers stock and stock option portfolios to stock price to test the relationship between managers risk preferences and hedging activities we find that as the sensitivity of managers stock and stock option portfolios to stock price increases firms tend to hedge more however as the sensitivity of managers stock option portfolios to stock return volatility increases firms tend to hedge less one of the agency costs associated with the corporate form of ownership comes from the risk aversion of the firm s managers the typical corporate manager has a significant portion of his or her wealth invested in the corporation both through portfolio holdings and the value of firm specific human capital as a result managers have an incentive to reduce firm risk more than may be desirable from the perspective of an unaffiliated diversified shareholder one way to mitigate managerial risk aversion is to provide the manager with contracts that have a payoff structure that is a convex function of the firm s stock price smith and stulz 1985 guay 1999 finds that stock options are an important way in which convexity is added to managers portfolios however as recognized by carpenter 2000 and lambert larcker and verrecchia 1991 stock options create two opposing effects on managerial incentives the first effect is sensitivity to stock return volatility due to the convex payoff structure of options the value of a manager s stock option portfolio increases with the volatility of the firm s stock returns this sensitivity to stock return volatility should ceteris paribus give the manager an incentive to take more risk the second effect is sensitivity to stock price this effect comes from the direct link between the payoff of an option and

corporate financial hedging with proprietary information abstract if a firm has information pertinent to its own dividend stream that is not made available to its shareholders it may be in the interests of the firm and its shareholders to adopt a financial hedging policy this is in contrast with the modigliani miller theorem which implies that with informational symmetry such financial hedging is irrelevant in certain cases hedging policies are identified that are unanimously supported by shareholders

the sensitivity of ceo wealth to equity risk an analysis of the magnitude and determinants abstract to control risk related incentive problems equity holders are expected to manage both the convexity and slope of the relation between firm performance and managers wealth i find stock options but not common stockholdings significantly increase the sensitivity of ceos wealth to equity risk cross sectionally this sensitivity is positively related to firms investment opportunities this result is consistent with managers receiving incentives to invest in risky projects when the potential loss from underinvestment in valuable risk increasing projects is greatest firms stock return volatility is positively related to the convexity provided to managers suggesting convex incentive schemes influence investing and financing decisions

the demand for energy in the uk a general equilibrium analysis abstract previous research into the demand for energy has treated economic activity as an explanatory variable however economic theory suggests that economic activity is not independent of energy prices and energy demand we explore the two way causality between energy demand and economic activity in the context of a macroeconometric model of the uk economy inter alia this study suggests that the demand for energy is more price elastic in general equilibrium than it is under the more conventional assumptions of partial equilibrium

estimating the value of employee stock option portfolios and their sensitivities to price and volatility the costs associated with compiling data on employee stock option portfolios is a substantial obstacle in investigating the impact of stock options on managerial incentives accounting choice financing decisions and the valuation of equity we present an accurate method of estimating option portfolio value and the sensitivities of option portfolio value to stock price and stock return volatility that is easily implemented using data from only the current year s proxy statement or annual report this method can be applied to either executive stock option portfolios or to firm wide option plans in broad samples of actual and simulated ceo option portfolios we show that these proxies capture more than 99 of the variation in option portfolio value and sensitivities sensitivity analysis indicates that the degree of bias in these proxies varies with option portfolio characteristics and is most severe in samples of ceos with a large proportion of out of the money options however the proxies explanatory power remains above 95 in all subsamples

tax incentives to hedge for corporations facing tax function convexity hedging lowers expected tax liabilities thereby providing an incentive to hedge we use simulation methods to investigate convexity induced by tax code provisions on average the tax function is convex although in approximately 25 percent of cases it is concave carrybacks and carryforwards increase the range of income with incentives to hedge other tax code provisions have minor impacts among firms facing convex tax functions average tax savings from a five percent reduction in the volatility of taxable income are about 5 4 percent of expected tax liabilities in extreme cases these savings exceed 40 percent if a firm faces a convex tax function then hedging that reduces the volatility of taxable income reduces the firm s expected tax liability for a firm facing some form of tax progressivity when taxable income is low its effective marginal tax rate will be low but when income is high its tax rate will be high if such a firm hedges the tax increase in circumstances where income would have been low is smaller than the tax reduction in circumstances where income would have been high thus lowering expected taxes in examining the importance of various motives to hedge researchers have employed two general methods survey and regression analysis there are potential problems with each for example some managers might view the information requested in a survey as proprietary or might hesitate to admit that they employ derivatives to speculate rather than hedge to employ regression methods researchers must generate proxies for tax status in addition to other firm characteristics to the extent that a tax variable e g whether the firm has a net operating loss carryforward proxies for factors such as financial distress as well as tax circumstances analysts face an identification problem in interpreting the results

do firms hedge in response to tax incentives there are two tax incentives for corporations to hedge to increase debt capacity and interest tax deductions and to reduce expected tax liability if the tax function is convex we test whether these incentives affect the extent of corporate hedging with derivatives using an explicit measure of tax function convexity we find no evidence that firms hedge in response to tax convexity our analysis does however indicate that firms hedge to increase debt capacity with increased tax benefits averaging 1 1 percent of firm value our results also indicate that firms hedge because of expected financial distress costs and firm size an increasing number of corporations use financial derivatives each year the international swaps and derivatives association reports that the notional value of outstanding otc swap contracts increased from 11 3 trillion in 1994 to more than 60 trillion by mid 2000 http 00www isda org this is interesting because financial theory tells us that corporate risk management enhances value only in the presence of costly market imperfections a number of empirical studies examine derivative holdings to identify which of the proposed theoretical incentives and imperfections lead to corporate hedging our paper adds to the hedging literature by testing whether corporations respond to two tax related incentives to hedge the incentive to reduce volatility thereby increasing debt capacity and the tax benefits of debt and the incentive to reduce expected tax liabilities by reducing the volatility of taxable income we also use a refined dependent variable to measure net

financial decision making are women really more risk averse 40 males 33 females gain gambling gain domain loss gambling loss domain a contextual frames b abstract gambling frames studies the application of experimental methods provided stronger control of the economic environment in which decisions were made we elicited data which call into question the prevalence of stereotypic risk attitudes in financial decision making first we find that the comparative risk propensity of male and female subjects is strongly dependent on the financial decision setting second and more important we observe no gender differences in risk propensity when subjects face contextual decisions since in practice financial decisions are always contextual our results suggest that the above gender stereotype may not reflect true male and female attitudes toward financial risks i gender specific risk behavior an experimental design our experiment was designed to examine gender specific risk propensity in decisions relevant for investors and managers table 1 gives an overview of the experimental design in the main treatment we implemented risky choices in the form of investment and insurance decisions choice behavior in this treatment henceforth called the context treatment directly measures the risk behavior of male and female subjects in contextual financial decisions we also ran a control treatment in which the same risky choices were presented as abstract gambling decisions this control treatment henceforth called the abstract treatment allows us to validate the risk behavior induced by our experimental procedure in the light of the above mentioned gambling evidence in the context treatment subjects were confronted with risky choices in two different decision contexts subjects first had to complete a series of investment decisions they were then presented with a series of identical choices this time however framed as insur1 wealth effects from income differences outside the laboratory may still affect risk behavior in our experiment they are controlled for in our model 2 experimental instructions are available in german from the authors or in english from our web page www wif ethz ch publikationen htm ance decisions each investment and insurance decision incorporated a choice between a risky lottery and a certain payoff with the series of choices implemented in the two frames we elicited our subjects certainty equivalents for the same four risky lotteries l1 l2 l3 l4 in both contexts we implemented two frames in the context treatment in order to measure the risk propensity of subjects toward both perceived gains and perceived losses in both frames all possible payoffs for each decision were positive in the investment frame these payoffs were also presented as gains while in the insurance frame the same payoffs were presented as losses relative to an initial endowment therefore elicited certainty equivalents in the investment frame measure subjects risk propensities in the gain domain while certainty equivalents in the insurance frame measure risk propensity in the loss domain if in contextual financial decisions female subjects are generally more risk averse than men our results should display ceteris paribus lower female certainty equivalents in both the investment and insurance frames 3 the four lotteries l1 l2 l3 and l4 each had two possible outcomes payoffs in swiss francs 1 sfr a 0 60 and their probabilities were 30 sfr 6 10 sfr 6 30 sfr 2 10 sfr 2 30 sfr 6 10 sfr 6 and 50 sfr 2 20 sfr 2 respectively 4 experimental evidence suggests that individual risk propensity will vary systematically between the gain and loss domain daniel kahneman and amos tversky 1979 383 vol 89 no 2 gender and economic transactions 3y16 my68 mp 383 friday dec 10 08 20 am lp aer my68 figure 1 differences in mean certainty equivalents ce between male and female subjects by frame note certainty equivalents and male female differences are measured in swiss francs in the abstract treatment we confronted a different group of subjects with exactly the same risky decisions as those in the main treatment however as mentioned before all choices in this control treatment were framed as abstract gambling decisions again two frames were implemented in the gaingambling and loss gambling frames we measured the risk attitudes of subjects toward gambles in the gain and loss domain respectively subjects in both treatments were told in advance that one of their choices would determine their experimental earnings further all subjects completed a post experimental questionnaire which yielded information on each subject s disposable income this information is necessary to exclude wealth effects due to income differences outside the laboratory as an explanation of gender specific choice behavior

enjoying the quiet life corporate governance and managerial preferences much of our understanding of corporations builds on the idea that managers when they are not closely monitored will pursue goals that are not in shareholders interests but what goals would managers pursue this paper uses variation in corporate governance generated by state adoption of antitakeover laws to empirically map out managerial preferences we use plant level data and exploit a unique feature of corporate law that allows us to deal with possible biases associated with the timing of the laws we find that when managers are insulated from takeovers worker wages especially those of white collar workers rise the destruction of old plants falls but the creation of new plants also falls finally overall productivity and profitability decline in response to these laws our results suggest that active empire building may not be the norm and that managers may instead prefer to enjoy the quiet life

introducing convexity into optimal compensation contracts abstract we study when it is appropriate to add a convex component such as stock options to an optimal managerial compensation contract we show that convexity is introduced when managers have moderate levels of relative risk aversion and decreasing absolute risk aversion in addition we study how convexity is affected as the distribution of outcomes becomes more skewed toward low outcomes here we show that while convexity increases when skewness is increased without regard to the effect on mean stock price the opposite effect results when increases in skewness leave the mean stock price unchanged

does option compensation increase managerial risk appetite this paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls under the manager s optimal policy the option ends up either deep in or deep out of the money as the asset value goes to zero volatility goes to infinity however the option compensation does not strictly lead to greater risk seeking sometimes the manager s optimal volatility is less with the option than it would be if he were trading his own account furthermore giving the manager more options causes him to reduce volatility managers with convex compensation schemes play an important role in financial markets this paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls the paper focuses on how the option compensation impacts the manager s appetite for risk when he cannot hedge the option position on one hand the convexity of the option makes the manager shun payoffs that are likely to be near the money under the optimal policy the manager either significantly outperforms his benchmark or else incurs severe losses furthermore in examples of optimal trading strategies asset volatility goes to infinity as asset value goes to zero yet option compensation does not strictly lead to greater risk seeking as asset value grows large or if the evaluation date is far away the manager moderates asset risk for example if the manager has constant relative risk aversion crra asset volatility converges to the merton constant as asset value goes to infinity in some situations the manager actually chooses a lower asset volatility than he would if he were investing on his own because the leverage inherent in his option magnifies his exposure to the asset volatility in addition with all constant or decreasing absolute risk averse utility functions from the hyperbolic absolute risk averse hara class giving the manager more options causes him to reduce asset volatility in the crra case for example the manager targets a fixed volatility for his personal

on the determinants of corporate hedging finance theory indicates that hedging increases firm value by reducing expected taxes expected costs of financial distress or other agency costs this paper provides evidence on these hypotheses using survey data on firm s use of forwards futures swaps and options combined with computstat data on firm characteristics of 169 firms in the sample 104 firms use hedging instruments in 1986 the data suggest that firms which hedge face more convex tax functions have less coverage of fixed claims are larger have more growth options in their investment opportunity set and employ fewer hedging substitutes