An Empirical Analysis of the Role of Risk Aversion in Executive Compensation Contracts

Abstract

This paper empirically tests the principal-agent model prediction that the use of performance measures for incentive purposes is affected by the agent’s risk aversion. We find that the use of both accounting and market performance measures in executive compensation contracts decreases as the level of risk aversions increases. We further find that agent-specific characteristics, i.e., risk aversion, become more important in designing executive compensation contracts when performance measures are less useful due to measure-specific characteristics.