ABSTRACT
This chapter deals with major issues regarding the link between different forms of risk and the structure of pay. The concept of risk is perhaps one of the most central constructs in executive compensation research. While risk bearing and risk taking by managers have been increasingly discussed by compensation committees, HR experts, and scholars in the field, uniform metrics of risks and how to apply such metrics in determining executive compensation remains unclear. The concepts of risks are crucial elements in compensation design. Economist's views on risk indicate that individual choices reflect the shape of their utility function. The shape of the function invokes specific preference labels of 'risk averse', 'risk neutral', and 'risk seeking'. Challenging the inflexible assumption from agency theory that decision makers hold consistent risk preferences, Wiseman and Gomez-Mejia developed the behavioral agency model (BAM), which is based on a long stream of research that has flowed from Kahneman and Tversky's prospect theory.
