Abstract:Unemployment risk influences workers’ incentives to invest in firm-specific human capital. In this paper, we investigate the impact of unemployment risk on CEO’s risk-taking incentive compensation. Exploiting state-level changes in unemployment benefits, we find that after unemployment insurance benefits become more generous, boards increase the convex payoff structure of CEO pay to encourage risk-taking. The increase in convexity payoff structures is stronger when CEO wealth is tied closely to firm performance and in labor-intensive industries, but attenuated by unionization. Our findings suggest that boards internalize labor market frictions in firms’ risk-taking decisions and executive compensation is one mechanism used.
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