Risk-Taking Incentives and Losses in the Financial Crisis
- 1 January 2011
- preprint
- Published by Elsevier in SSRN Electronic Journal
Abstract
We argue that incentives to take equity risk ("equity incentives") only partially capture incentives to take asset risk ("asset incentives"). This is because leverage, while central to the theory of risk-shifting, is not explicitly considered by equity incentives. Employing measures of asset incentives that account for leverage, we find that asset risk-taking incentives can be large compared to incentives to increase firm value. Moreover, stock holdings can induce substantial risk-taking incentives, qualifying common beliefs regarding the central role of stock options.Finally, asset incentives help explain asset risk-taking of U.S. financial institutions before the 2007/08 crisis.Keywords
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