International Finance Discussion Papers (IFDP)

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March 2016

Managerial Compensation under Privately-Observed Hedging

Qi Liu and Bo Sun

Abstract:

This paper studies how private information in hedging outcomes affects the design of managerial compensation when hedging instruments serve as a double-edged sword in that they may be used for both corporate hedging and earnings management. On the one hand, financial vehicles can offer customized contracts that are closely tailored to manage specific risk and improve hedging efficiency. On the other hand, involvement in hedging may give rise to manipulation through misstatement of the value estimates. We show that the use of privately-observed hedging may actually require greater pay-for-performance in managerial compensation. The cross-sectional variations in managerial compensation lend support to our model.

Keywords: managerial compensation, corporate hedging

DOI: http://dx.doi.org/10.17016/IFDP.2016.1160

PDF: Full Paper

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Last Update: June 19, 2020