Abstract
Research Summary: This article examines the consequences of incentive slope and shape on performance and risk-taking. It focuses on how slope—incentive intensity—influences risk-taking, and how shape—nonlinearity—influences performance. We use quasi-random variation in the context of the hedge-fund industry to separate slope and shape effects. Our results demonstrate that shape has large and important effects on performance, and that slope affects risk-taking. The evidence suggests that poor performance in the industry is often due to bad bets—excessive risk-taking that reduces performance—taken in response to nonlinear incentives. The findings suggest that, although nonlinear incentives are widely used, they can, under certain circumstances, predictably produce pernicious effects on organizational performance. Managerial Summary: This article examines how nonlinear incentive contracts—such as contracts that reward performance above a threshold substantially more than below it—influence managerial behavior. Using the hedge-fund industry, in which nonlinear incentives are ubiquitous, as a laboratory, we find that nonlinear incentive schemes cause managers who are “close” to, but below, the performance threshold to take bad bets—excessive risk-taking that reduces performance. The findings suggest that, although nonlinear incentives are widely used, they can, under certain circumstances, predictably produce pernicious effects on organizational performance.
Original language | English (US) |
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Pages (from-to) | 288-310 |
Number of pages | 23 |
Journal | Strategic Management Journal |
Volume | 44 |
Issue number | 1 |
DOIs | |
State | Published - Jan 2023 |
Bibliographical note
Funding Information:For helpful comments and discussions, we are grateful to Jay Barney, Ernesto Dal Bó, Ulrike Malmendier, John Morgan, Santiago Oliveros, Paul Oyer, Robert Seamans, Steve Tadelis, Neil Thompson, Catherine Wolfram, Noam Yuchtman, and Todd Zenger, participants in seminars at Columbia, Dartmouth, Georgetown, Northwestern, Stanford, University of California at Berkeley, University of Rochester, University of Toronto, and University of Western Ontario, as well as at the Academy of Management Annual Meeting, CCC, and the Western Economic Association Annual Meeting for helpful comments and discussions. de Figueiredo thanks the Kauffman Foundation and Shelef thanks the Coleman Fung Risk Management Research Center and White Fellowship for financial support. All remaining errors are our own.
Publisher Copyright:
© 2019 John Wiley & Sons Ltd.
Keywords
- contracting
- incentives
- performance
- risk