Managerial risk incentives and investment related agency costs

- We assess the impact of compensation based incentives on agency costs.
- Well structured compensation based incentives significantly reduce agency costs.
- Delta has a negative effect on agency costs.
- Vega reduces agency costs and is more effective where risk is higher.

We assess the impact of compensation based incentives together with monitoring mechanisms on investment related agency costs. The results indicate that well structured compensation based incentives significantly reduce agency costs. Managerial firm based wealth delta has a significant, negative effect on agency costs for firms in all size categories. The significance of managerial firm based wealth vega in reducing agency costs is concentrated in small firms, suggesting that vega exposure is more effective where risk is higher. The significance of cash compensation in reducing agency costs is concentrated in the large firms. This result implies that higher cash compensation reduces agency costs by allowing risk-averse managers the opportunity to diversify outside the firm.