Does risk matter for executive compensation?

• DOI: https://doi.org/10.1108/CG-12-2020-0536
• Published date: 24 August 2021
• Date: 24 August 2021
• Pages: 159-172
• Subject Matter: Strategy,Corporate governance
• Author: Mehtap Aldogan Eklund

Does risk matter for executive

compensation?

Mehtap Aldogan Eklund

Abstract

Purpose –The purpose of this study is to examine whether chief executive officer (CEOs) are paid

for the systematic and/or unsystematic risks and whether there is any optimum risk premium level in

the executive pay.

Design/methodology/approach –Firm and year fixed effect panel data regression was used to

estimate the relationship between total CEO compensation and systematic (market) and unsystematic

(firm) risks.

Findings –There is no nexus between CEO pay and unsystematic (divers ifiable) risk; however, the

association between CEO compensation and systematic (undiversifiable) risk is positively significant in line

with agency theory. Moreover, it is revealed that thi s positive relationship has an optimum point (curvilinear).

Research limitations/implications –This paper contributes to the controversial argument in the

literature by investigatingthe situation in the Swiss market. Switzerland is an exemplarycountry because

of its direct democracy(consensus) structure for executive pay. Thisstudy is limited by the fact that only

total CEO compensationis analyzed.

Practical implications –As a practical implication, it is shown that after the optimal point, the higher

compensation does not motivate the CEOsto take higher risks and does not provide the organizations

with any additionalbenefit.

Originality/value –The finding of this study supports agency theory’s risk premium assumption

and provides additional evidence to the contradictory results in the literature with a new country

setting that has paramount importance in executive compensation phenomena. It is a comparative

finding with prior literature also outlines the future research area in the risk and compensation

literature.

Keywords Executive compensation, Agency theory, Systematic risk, Unsystematicrisk,

Optimum risk premium

Paper type Research paper

Introduction

There are two strands of thought that analyze the relationship betw een executive

compensation and risk. The first strand concentrates on risk as a driving fa ctor for

compensation. The second strand takes the opposite perspective by suggesting that

executive compensation encourages different forms of risk behavior acr oss firms

(Abrokwah et al., 2018;White, 2018). Both arguments are remarkable phenomena in

the literature. The purpose of this paper is to investigate whether total e xecutive

compensation is aligned with the systematic and unsystematic risks and whether

there is any optimal risk premium level in the executive pay. Thus, it contributes t o the

first strand of the arguments by believing that the risk is one of the salient predictors

of chief executive officer (CEO) compensation, which is built upon agency theory’s

risk premium prediction and the concepts of “risk-based compensation.”

This topic took on added importance during and after the crises. Hilb (2016)

emphasized the importance of the risk premium in remuneration packages. FINMA

Mehtap Aldogan Eklund is

Assistant Professor at the

Department of

Accountancy, University of

Wisconsin-La Crosse, La

Crosse, Wisconsin, USA.

Received 7 December 2020

Revised 15 March 2021

26 April 2021

4 June 2021

Accepted 26 July 2021

Conflict of interest: The author

declares that she has no

conflict of interest.

Funding: The author declares

that this study was not funded

by any organizations.

Ethical standards: The author

declares that this study

complies with ethical

standards. Informed consent:

The author declares that this

research does not involve

humans and/or animals.

DOI 10.1108/CG-12-2020-0536 VOL. 22 NO. 1 2022, pp. 159-172, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 159