CEO compensation has increased substantially over the past 15 years, but so has forced turnover. Motivated by this observation, we investigate whether part of the development of CEO pay can be explained by a premium which compensates CEOs for increased job risk. We find that for the CEOs of the largest US corporations, a one percentage point increase in turnover risk is, on average, associated with about 4% more in terms of total compensation. This relation is much stronger in the cross section than it is over time, and it does not appear to be driven by endogeneity. Our findings are consistent with a model of effcient contracting, but are harder to reconcile with a model of entrenched CEOs.
In spite of the fact that they can draw on a larger, more liquid and more diversiedpool of capital than the equity of reinsurance companies, nancial markets have failedto displace reinsurance as the primary risk-sharing vehicle for natural catastropherisk. We show that this failure can be explained by dierences in information gatheringincentives between nancial markets and reinsurance companies. Using a simple modelof an insurance company that seeks to transfer a fraction of its risk exposure eitherthrough nancial markets or through traditional reinsurance, we nd that the supplyof information by informed traders in nancial markets may be excessive relative to itsvalue for the insurance company, causing reinsurance to be preferred. We show thatwhether traditional reinsurance or nancial markets are ultimately selected dependscrucially on the information acquisition cost structure and on the degree of redundancyin the information produced. Limits on the ability of informed traders to protablytake advantage of their information make the use of nancial markets more likely.
This paper examines the investment strategies of regulated companies in abatement technologies, market participants' trading behaviors, and the liquidity level in an inter-temporal cap{and{trade market using laboratory experiments. The experimental analysis is performed under varying market structures: the exclusive presence of regulated companies; the inclusion of subjects not liable for compliance with environmental regulations; the availability of plain vanilla options. In line with theoretical models on irreversible abatement investment, the first experiment shows that regulated companies trade permits at a premium. At the same time the existence of a strict enforcement structure effectively prompts investments in new technologies.The second experiment shows that the presence of non-regulated companies adds liquidity to the market and does not increase price volatility. The last experiment enablesus to investigate the impact of the presence of cash-settled options contracts on the trading strategies of regulated companies. Their expected emissions appears to play a significant rolein the choice of their options strategy.
Prompt Corrective Action (PCA) is a system of predetermined capital/asset ratios that trigger supervisory actions by a banking regulator. Our paper addresses the optimality of this regulation system by adapting a dynamic model of entrepreneurial fi?nance to banking regulation. In a dynamic moral hazard setting, we fi?rst derive the optimal contract between the banker and the regulator and then implement it by a menu of regulatory tools. Our main ?findings are the following: ?first, the insurance premium is a risk-based premium where the risk is measured by the capital level; second, our model implies a capital regulation system that shares several similarities with the US PCA. According to our proposed system, regulatory supervision should be realized in the spirit of gradual intervention and the book-value of capital is used as information to trigger intervention. Banks with high capital are not subject to any restrictions. Dividend distribution is prohibited in banks with intermediate level of capital. When banks have low capital level, a plan of recapitalization is required and in the worst case, banks are placed in liquidation.
This paper addresses the desirability of competition in banking industry. In a model where banks compete on both deposit and loan markets and where banks can use monitoring technology to control entrepreneurs' behavior, we investigate three questions: what are the effects of competition on banks' monitoring incentives? Does competition hurt banks' stability? What can be devices to correct potential negative effects of competition vis à vis ?financial stability? We ?find that impacts of competition on banks' monitoring incentives can be decomposed into two effects: one on the attractiveness of monitoring and the other on the monitoring efficiency. The fi?rst effect operates through the link between competition and loan margin. The second effectcomes from the fact that marginal effect of monitoring on entrepreneur's effort depends on loan rate. We characterize the sufficient condition under which competition will increase monitoring incentives as well as banks' stability. For the third question, we focus on the role of capital requirement and claim that with capital requirement, we can attain a weak correction but not strong correction.
A number of empirical studies seem to reject the additive separability of preferences that is assumed in most theoretical models of the life cycle. We show that, when additive separability is abandoned and interactions between consumptions at different dates are taken into account, an interesting relation emerges between risk aversion and length of the planning horizon. Specifically, we show that when consumptions at different dates are specific substitutes, risk aversion increases with horizon length. This may explain the surprising empirical finding that individuals seem to increase the share of wealth held in risky assets as they become older. (JEL: D11, D91, G11)
We offer a rational expectations model of the dynamics of innovative industries. The fundamentalvalue of innovations is uncertain and one must learn whether they are solid or fragile. Also, when theindustry is new, it is difficult to monitor managers and make sure they exert the effort necessary toreduce default risk. This gives rise to moral hazard. In this context, initial successes spur optimismand growth. But increasingly confident managers end up requesting large rents. If these becometoo high, investors give up on incentives, and default risk rises. Thus, moral hazard gives rise toendogenous crises and fat tails in the distribution of aggregate default risk. We calibrate our modelto fit the stylized facts of the MBS industry’s boom and bust cycle.2
This paper sets up a model for analysing the problem of rational exit where the stopping time itself is part of the integration problem. The model development is for the case of smoking. Smoking produces pleasure, pain and addiction. Our model captures all these elements and using Brownian notion and continuous martingales establishes that “quit smoking” campaigns require a two pronged attack: educational and medical. It develops a new technique which can be applied to other stopping problems where stopping time itself is part of the integration problem.
In this article, we describe the various sorts of American Parisian options and propose valuation formulae. Although there is no closed-form valuation for these products in the non-perpetual case, we have been able to reformulate their price as a function of the exercise frontier. In the perpetual case, closed-form solutions or approximations are obtained by relying on excursion theory. We derive the Laplace transform of the first instant Brownian motion reaches a positive level or, without interruption, spends a given amount of time below zero. We perform a detailed comparison of perpetual standard, barrier and Parisian options
