How Executive Incentive Design Affects Risk-Taking: A Literature Review

Due to agency problems, firms use management control systems to motivate employees to act in the firms’ interest. This process includes motivating employees to increase effort as well as aligning risk preferences. Whereas Bonner and Sprinkle (2002) review and discuss research findings regarding the effects of monetary incentives on effort and performance, we approach the latter component, i.e., risk. The purpose of this literature review is to systematically present and review research findings regarding the effects of monetary incentives on risk-taking. We thus distinguish between individual performance-based pay, equity-based pay and tournament compensation. Further, implications for incentive system design in practice as well as paths for future research are discussed. On the one hand, we provide suggestions on how to increase employee risk-taking and reduce loss-aversive behavior. On the other hand, we discuss instruments that prevent employees from taking high (excessive) risks. Ultimately, when designing incentive systems, it is always crucial to consider the potential effects on both effort and risk-taking.