Reining in Excessive Risk Taking by Executives : Experimental Evidence

Compensation of executives by means of equity has long been seen as a means to tie executives' income to company performance, and thus as a solution to the principal-agent dilemma created by the separation of ownership and management in publicly owned companies. The overwhelming part of such equity compensation is currently provided in the form of stock-options. Recent events have however revived suspicions that the latter may induce excessive risk taking by executives. In an experiment, we find that subjects acting as executives do indeed take risks that are excessive from the perspective of shareholders if compensated through options. Comparing compensation mechanisms based on stock-options to long-term stock-ownership plans, we find that the latter significantly reduce the uptake of excessive risks by aligning the executives' interests with those of shareholders. Introducing an institutionalized accountability mechanism consisting in the requirement for executives to justify their choices in front of a shareholder reunion also reduces excessive risk taking, and appears to be even more effective than long-term stock-ownership plans. A combination of long-term stock-ownership plans and increased accountability thus seem a promising direction for reining in excessive risk taking by executives.executive compensation ; stock-options ; incentives ; accountability ; risk taking

Risk Taking of Executives under Different Incentive Contracts: Experimental Evidence

Classic financial agency theory recommends compensation through stock options rather than shares to induce risk neutrality in otherwise risk averse agents. In an experiment, we find that subjects acting as executives do also take risks that are excessive from the perspective of shareholders if compensated through options. Compensation through restricted company stock reduces the uptake of excessive risks. Even under stock-ownership, however, experimental executives continue to take excessive risks—a result that cannot be accounted for by classic incentive theory. We develop a basic model in which such risk-taking behavior is explained based on a richer array of risk attitudes derived from Prospect Theory. We use the model to derive hypotheses on what may be driving excessive risk taking in the experiment. Testing those hypotheses, we find that most of them are indeed borne out by the data. We thus conclude that a prospect-theory-based model is more apt at explaining risk attitudes under different compensation regimes than traditional principal-agent models grounded in expected utility theory.prospect theory; expected utility theory; risk attitude; executive compensation; reference dependence; experimental finance

Population ageing and consumption demand in Belgium

This paper analyses the effect of population ageing on consumptions aggregates in Belgium. Since consumption expenditures change markedly over the life-cycle, the structure of aggregate consumption is likely to change in the course of population ageing. First, we estimate the effect of age on expenditures for 10 composite goods coming from household’s surveys. This is done using a pseudo-panel method. Second, age-specific profiles are used to forecast composition of consumption until 2050. The results point to increases in health, housing and leisure expenditures and decreases in equipment, clothing and transport expenditures. These changes are relatively moderate but non negligible. They will translate in sectoral shifts and most probably in changes in sectoral employment.Consumption, demographic ageing, projections.

Measuring Poverty Without The Mortality Paradox

Under income-differentiated mortality, poverty measures reflect not only the "true" poverty, but, also, the interferences or noise caused by the survival process at work. Such interferences lead to the Mortality Paradox: the worse the survival conditions of the poor are, the lower the measured poverty is. We examine several solutions to avoid that paradox. We identify conditions under which the extension, by means of a fictitious income, of lifetime income profiles of the prematurely dead neutralizes the noise due to differential mortality. Then, to account not only for the "missing" poor, but, also, for the "hidden" poverty (premature death), we use, as a fictitious income, the welfare-neutral income, making indifferent between life continuation and death. The robustness of poverty measures to the extension technique is illustrated with regional Belgian data.premature mortality ; income-differentiated mortality ; poverty measurement ; censored income profile

Disability in Belgium: there is more than meets the eye

The paper provides a perspective on the development of the Belgian disability insurance system. Using both survey and administrative data, it sketches a picture of the (changing) factors leading towards disability, as well as the outcomes in terms of program participation. The paper shows the key role of integrating other forms of early retirement programs into the analysis. The main findings are an unspectacular trend in the number of DI beneficiaries over time combined with a strong expansion of (early-) retirement schemes.

Risk Taking of Executives under Different Incentive Contracts: Experimental Evidence

Classic financial agency theory recommends compensation through stock options rather than shares to induce risk neutrality in otherwise risk averse agents. In an experiment, we find that subjects acting as executives do also take risks that are excessive from the perspective of shareholders if compensated through options. Compensation through restricted company stock reduces the uptake of excessive risks. Even under stock-ownership, however, experimental executives continue to take excessive risks—a result that cannot be accounted for by classic incentive theory. We develop a basic model in which such risk-taking behavior is explained based on a richer array of risk attitudes derived from Prospect Theory. We use the model to derive hypotheses on what may be driving excessive risk taking in the experiment. Testing those hypotheses, we find that most of them are indeed borne out by the data. We thus conclude that a prospect-theory-based model is more apt at explaining risk attitudes under different compensation regimes than traditional principal-agent models grounded in expected utility theory

On the welfare state performance in the European Union

In this paper we use data on five social inclusion indicators (poverty, inequality, unemployment, education and health) to assess and compare the performance of 27 European welfare states (EU27) in 2008. Aggregate measures of performance are obtained using index number methods similar to those employed in the construction of the widely used Human Development Index (HDI). These are compared with alternative measures derived from data envelopment analysis (DEA) methods. We are particularly interested by the comparison between EU15 and the 12 newcomers (EU12). As it will appear among the newcomers some countries are ranking among the top performers and others are relegated in the bottom of the ranking.

Tax Evasion, Welfare Fraud, and "The Broken Windows" Effect: An Experiment in Belgium, France and the Netherlands

In a series of experiments conducted in Belgium (Wallonia and Flanders), France and the Netherlands, we compare behavior regarding tax evasion and welfare dodging, with and without information about others’ behavior. Subjects have to decide between a 'registered' income, the realization of which will be known to the tax authority for sure, and an 'unregistered' income that will only be known with some probability. This unregistered income comes from self-employment in the Tax treatment and from black labor supplementing some unemployment compensation in the Welfare treatment. Subjects have then to decide on whether reporting their income or not, knowing the risk of detection. The results show that (i) individuals evade more in the Welfare treatment than in the Tax treatment; (ii) many subjects choose an option that allows for tax evasion or welfare fraud but report their income honestly anyway; (iii) examples of low compliance tend to increase tax evasion while examples of high compliance exert no influence; (iv) tax evasion is morefrequent in France and the Netherlands; Walloons evade taxes less than the Flemish. There is no cross-country difference in welfare dodging.tax evasion, social fraud, social comparisons, cross-country comparisons, experiments