"More Manipulation, Less Risk-Taking?"
Executive compensation has undergone a radical shift in the United States
over the last two decades, from a cash-based system to a stock-based system.
This shift, which was intended to improve firm performance, is often said to
have two main shortcomings: it generates excessive risk-taking, and it drives
managers to engage in manipulative practices. Some scholars consider these
problems to be so severe that they blame the first for the 2007-2010 financial
crisis and the second for the wave of Enron-style fraud in 2001-2002.
Interestingly, to date, no one has investigated the interaction between these
two types of adverse incentives, for risk-taking and for manipulation. This
Article seeks to fill this gap in the literature. We show that these two
undesirable types of behavior—both of which generate benefits for managers at
the expense of
shareholders—substitute for each other, from a manager's perspective. Managers therefore face a tradeoff between risk taking and manipulation. Greater manipulation, counter-intuitively, restrains excessive risk-taking. As a result, when regulation improves disclosure and impedes manipulation, risk-taking may erupt. Policy-wise, improved disclosure and anti-manipulation regulatory policies should be accompanied by measures designed to prevent excessive risk-taking by managers.