The Wall Street crash in 2009 was preceded by years of increased risk-taking by executives. What influences whether these and other CEOs make risky business decisions? Performance goals but not compensation compared to peers, according to a study co-authored by Robert Wiseman, professor, chair and Eli Broad Legacy Fellow of Management at MSU’s Broad College of Business.
Whether a CEO thinks they are winning or losing influences the risks they are willing to take. Reaching performance goals increases monetary awards and perceived employment security, thus they see themselves as winning and take fewer additional risks. CEOs that have not met their targets, however, tend to take on more risks in order to catch up to those targets which, if not met, could cost them their job – the biggest mediating factor in determining whether a CEO will take risks. On the other hand, the study found that comparing one’s compensation to that of peers did not influence risk-taking of CEOs.
Understanding this research provides companies the opportunity to influence CEO risk-taking. “Companies should be careful about how high they want to set performance goals for executives because they will try to achieve them,” explains Wiseman. “If they aren’t meeting those goals, then they will take on risk, sometimes excessive risks to achieve the targets contained in their contracts.”
But there is much more that companies must consider beyond performance goals. Wiseman cautions, “Compensation designs at top management are very complex. We have yet to fully consider the interaction among all of the elements of a contract to fully appreciate how CEOs might respond to these complex incentive agreements.”
Wiseman and scholars from Universidad Publica De Navarra in Pamplona, Spain, and Texas A&M University looked at a sample of 180 CEOs of U.S. firms that issued an IPO between 1993-95. Unlike previous studies which used lab or field measures, this study, which appears in Management Research, directly measured influences on CEO risk-tasking through CEO self-ranking of performance in relation to compensation contract targets, compensation related to peers and riskiness of specific business options.
Wiseman was awarded the 2012 Emerald Literati Network’s Outstanding Paper Award for this research. The award is determined by the journal’s editorial team based on papers from the previous year and honors outstanding contributions.