Explaining the Structure of CEO Incentive Pay with Decreasing Relative RiskAversion

Publication Date
Financial Markets Group Discussion Papers DP 693
Publication Authors

It is established that the standard principal-agent model cannot explain the structure of commonly used CEO compensation contracts if CRRA preferences are postulated. However, we demonstrate that this model has potentially a high explanatory power with preferences with decreasing relative risk aversion, in the sense that a typical CEO contract is approximately optimal for plausible preference parameters.