The Investment Channel of Monetary Policy: Executive Compensation Matters

Abstract

This paper investigates the role of executive compensation in the transmission of monetary shocks to corporate investments. We find that a managerial compensation structure that facilitates risk-taking (high Vega) is a positive and significant contributor to the translation of monetary shocks into subsequent corporate investments. The investments of high Vega firms are three times as sensitive to monetary shocks as the investments of low Vega firms. This mediating effect is robust across size, age, and leverage. We also show that the executive compensation Vega is highly responsive to monetary shocks, especially for firms with apriori preference for risk-taking. The design of executive compensation packages not only addresses agency problems within the firm but also has relevant macroeconomic consequences.