Risk-Taking Incentives and Risk Perceptions

Paper Session

Friday, Jan. 6, 2017 10:15 AM – 12:15 PM

Hyatt Regency Chicago, Michigan 2
Hosted By: American Economic Association
  • Chair: Alexander F. Wagner, Swiss Finance Institute and University of Zurich

Killer Incentives: Performance and Risk-Taking Among German Fighter Pilots, 1939-1945

Philip Ager
,
University of Southern Denmark
Leonardo Bursztyn
,
University of California-Los Angeles
Joachim Voth
,
University of Zurich

Abstract

German soldiers during WWII could earn a set of set of prestigious medals, awarded for valor on a cumulative basis. To demonstrate the effectiveness of these awards, we focus on fighter pilots, and examine the rate of aerial victories per month. We exploit differences in performance after the introduction of new awards to demonstrate the effectiveness of non-financial rewards. Pilots who qualified for the new medals achieved higher victory rates, at the cost of a slightly greater risk of death. Also, other pilots of similar quality reacted to awards by making greater efforts, leading to a higher kill rate. Depending on their quality, loss rates could rise substantially at the same time. This suggests that especially poorer pilots became more motivated, but 'tried too hard'. Overall, the German airforce undermined its effectiveness by introducing a set of high-powered incentives.

Rankings and Risk-Taking in the Finance Industry

Michael Kirchler
,
University of Innsbruck
Florian Lindner
,
University of Innsbruck
Utz Weitzel
,
Utrecht University

Abstract

Rankings are a pervasive feature of the finance industry. Although they have no direct monetary consequences, rankings provide utility for intrinsic (positive self-image) and extrinsic (status) reasons. We recruit a unique subject pool of 204 financial professionals and investigate how anonymous rankings influence risk-taking in investment decisions. We find that rankings increase risk-taking because of financial professionals’ desire for positive self-image. This particularly applies to underperformers, who take the highest risks. Incentivizing rankings monetarily does not further increase risk-taking. In a comparative study with 432 students we find that student behavior is not driven by rankings.

Managerial Incentives to Take Asset Risk

Marc Chesney
,
University of Zurich
Jacob Stromberg
,
UBS AG Switzerland
Alexander F. Wagner
,
Swiss Finance Institute and University of Zurich

Abstract

We argue that incentives to take equity risk ("equity incentives") only partially capture incentives to take asset risk ("asset incentives"). This is because leverage, while central to the theory of risk-shifting, is not explicitly considered by equity incentives. Employing measures of asset incentives that account for leverage, we find that asset risk-taking incentives can be large compared to incentives to increase firm value. Moreover, stock holdings can induce substantial risk-taking incentives, qualifying common beliefs regarding the central role of stock options. Finally, only asset incentives explain asset risk-taking of U.S. financial institutions before the 2007/08 crisis.

How Risk Simulations Improve Long-Term Investment Decisions

Meike Bradbury
,
University of Zurich
Thorsten Hens
,
Swiss Finance Institute
Stefan Zeisberger
,
State University of New York-Stony Brook

Abstract

Risk simulations, which dynamically demonstrate investors the possible consequences of their investment decisions, were shown to play an integral part in comprehending the risk-return trade-off and improving investment decision making. Up to now, studies have taken a static, short-term perspective focusing on just the initial investment decision. We analyze the benefits of risk simulations in a long-term experiment in which investors experience intermediate investment success and can adjust their investment strategy along the way. We find results underscoring the positive effects of risk simulations on investors’ understanding of the risk-return trade-off. Also, investors who do not use simulations need multiple investment periods until they show stable average risk taking behavior.
Discussant(s)
Konrad Raff
,
Norwegian School of Economics
Sandro Ambuehl
,
Stanford University
Kelly Shue
,
University of Chicago
James Choi
,
Yale University
JEL Classifications
  • D0 - General
  • G0 - General