Production and hedging implications of executive compensation schemes |
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| Institution: | 1. The Graduate School of Management, University of Haifa, Mount Carmel, Haifa 31905, Israel;2. The Faculty of Management, Tel Aviv University, Tel Aviv 69978, Israel;1. Instituto de Ciencias Físicas y Matemáticas, Universidad Austral de Chile, Valdivia, Chile;2. Department of Mathematics and Institute of Systems Science, Research and Postgraduate Support, Durban University of Technology, PO Box 1334, Durban 4000, South Africa;3. School of Mathematics, Statistics and Computer Science, University of KwaZulu-Natal, Private Bag X54001, Durban 4000, South Africa;4. Department of Mathematics and Statistics, University of Cyprus, Lefkosia 1678, Cyprus;1. Molecular and Surface Physics, Bielefeld University, D-33615 Bielefeld, Germany;2. Institut für Silizium-Photovoltaik, HZB, Kekuléstrasse 5, D-12489 Berlin, Germany;3. IEK5-Photovoltaik, Forschungszentrum Jülich GmbH, D-52425 Jülich, Germany;4. Institut für Innovationstransfer an der Universität Bielefeld, Universitätsstr. 25, D-33615 Bielefeld, Germany |
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| Abstract: | This paper connects executive compensation with hedging and analyzes a crucial shareholders and managers agency source that evolves from the pricing of the hedging device. The shareholders are risk-neutral, while the risk-averse manager hedges the price risk of the manufactured quantity, and his compensation package includes equity-linked compensation-stock grants. Only when the hedging instrument's pricing includes a risk premium, hedging is costly to the shareholders, while it is costless to the manager. Then from the owners' point of view, we observe managerial over-hedging, increasing in the equity-linked compensation level. This result leads to a violation of the classical production and hedging separation theorem. We conclude that, in the case where the hedging device's pricing bears a risk premium, shareholders can regulate the corporate value diversion to managers through diminishing the managerial equity-linked compensation scheme or by putting restrictions on the extent of hedging activities of executives. |
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