Uncertainty, risk, and incentives: Theory and evidence

Zhiguo He, Si Li, Bin Wei, Jianfeng Yu

Research output: Contribution to journalArticlepeer-review

30 Scopus citations

Abstract

Uncertainty has qualitatively different implications than risk in studying executive incentives. We study the interplay between profitability uncertainty and moral hazard, where profitability is multiplicative with managerial effort. Investors who face greater uncertainty desire faster learning, and consequently offer higher managerial incentives to induce higher effort from the manager. In contrast to the standard negative riskincentive trade-off, this "learning-by-doing" effect generates a positive relation between profitability uncertainty and incentives. We document empirical support for this prediction.

Original languageEnglish (US)
Pages (from-to)206-226
Number of pages21
JournalManagement Science
Volume60
Issue number1
DOIs
StatePublished - Jan 2014

Keywords

  • Executive compensation
  • Learning
  • Optimal contracting
  • Risk-incentive trade-off
  • Uncertainty

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