The masquerade ball of the CEOs and the mask of excessive risk

Abstract

Two well-known explanations for excessive risk taking by CEOs are limited liability, which protects them from the downward risks of their project choices, and convex compensation schemes that encourage risk taking. This paper provides a career-concerns-based motive for why a CEO might choose an excessively risky project even in the absence of them. A CEO of unknown managerial ability could be fired if she is found to be below average. To limit this layoff risk, she tries to conceal her true type by choosing excessively risky projects. Excessive risk taking makes the firm unable to determine if a poor outcome resulted from incompetency or negative risk realization. (C) 2016 Elsevier B.V. All rights reserved.