Not all Risk Taking is Born Equal: The Behavioral Agency Model and CEO's Perception of Firm Efficacy

• Author: Marianna Makri,Luis R. Gomez‐Mejia,Geoffrey Martin,Nathan Washburn
• DOI: http://doi.org/10.1002/hrm.21624
• Published date: 01 May 2015
• Date: 01 May 2015

Human Resource Management, May–June 2015, Vol. 54, No. 3. Pp. 483–498

© 2014 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI:10.1002/hrm.21624

Correspondence to: Luis R. Gomez-Mejia, Mendoza College of Business, University of Notre Dame, Notre Dame, IN

46556-5646, Phone: 574-631-3809, E-mail: lgomezme@nd.edu

NOT ALL RISK TAKING IS BORN

EQUAL: THE BEHAVIORAL AGENCY

MODEL AND CEO’S PERCEPTION

OFFIRM EFFICACY

GEOFFREY MARTIN, NATHAN WASHBURN,

MARIANNA MAKRI, AND LUIS R. GOMEZ-MEJIA

We examine the relationship between agent (CEO) risk bearing and the quality

of executive risk-taking outcomes, by examining the contingency effect of CEO

perceived fi rm effi cacy. In doing so, we extend the behavioral agency model

(BAM) beyond predictions of risk magnitude to examining how CEO risk-taking

outcomes differ qualitatively in response to risk bearing. We argue that CEO risk

bearing (due to stock options or cash compensation) will positively infl uence per-

formance outcomes in the presence of higher perceived fi rm effi cacy. However,

this positive infl uence reverses when effi cacy is lower. We demonstrate the utility

of fi rm effi cacy in exploring the effect of agent risk bearing on performance out-

comes and provide the insight that the CEO pay-performance relationship is

infl uenced by the CEO’s perception of fi rm effi cacy. © 2014 Wiley Periodicals, Inc.

Keywords: behavioral agency, perceived fi rm effi cacy, risk, R&D

In this study, we argue that the relationship

between agent risk bearing and firm perfor-

mance is dependent on the CEO’s perception

of firm efficacy. We do so by drawing upon

the behavioral agency model (BAM; Wiseman

& Gomez-Mejia, 1998) and literature developing

the concept of firm efficacy. The BAM as origi-

nally formulated draws upon agent risk bearing,

such as risk bearing associated with executive

compensation, to predict the magnitude of agent

risk taking. For instance, numerous studies have

utilized the BAM to predict a negative relation-

ship between agent (CEO) risk bearing and risk

taking (Devers, McNamara, Wiseman, & Arrfelt,

2008; Larraza-Kintana, Wiseman, Gomez-Mejia,

& Welbourne, 2007; Martin, Gomez-Mejia, &

Wiseman, 2013). Advancing this line of research,

our study extends the BAM in two significant

ways. First, rather than predict risk magnitude, we

utilize the BAM to examine performance outcomes

(success of risk taking) associated with agent risk

bearing. Second, we incorporate the CEO’s percep-

tion of firm efficacy as a contingency influencing

the performance effect of agent risk bearing. In

doing so, we address a question that has received

little research attention within the agency litera-

ture: When or under what conditions is agent risk

bearing good or bad for shareholders?

Agency research has previously suggested that

executive risk bearing generated through com-

pensation—and the risk aversion it leads to—

will negatively influence performance outcomes

(Coffee, 1998; Jensen & Meckling, 1976; Wiseman

& Gomez-Mejia, 1998). The logic behind this

484 HUMAN RESOURCE MANAGEMENT, MAY–JUNE 2015

Human Resource Management DOI: 10.1002/hrm

The failure to

pursue higher-risk

but higher-value

projects is argued to

create agency costs

for shareholders

due to suboptimal

investment choices

and associated

inferior performance

outcomes.

and outcomes (Lindsley et al., 1995), this virtu-

ous cycle of success-induced efficacy generating

future successes has yet to be applied to the study

of executive risk taking and the performance con-

sequences of agent risk bearing. Given the CEO’s

perception of firm efficacy appears to influence

their search for and choice of strategic alterna-

tives, we argue that it is likely to influence the

quality of risk taking and therefore the perfor-

mance outcomes associated with that risk taking.

We do so by examining the moderation effect of

CEO perception of firm efficacy on the relation-

ship between CEO risk bearing and performance

outcomes.

Drawing on a sample of 297 US publicly

traded technology-intensive firms, we find sup-

port for our prediction that the CEO’s perception

of firm efficacy positively moderates the relation-

ship between CEO risk bearing and R&D perfor-

mance outcomes. That is, when the CEO perceives

higher levels of firm efficacy, CEO risk bearing is

positively related to R&D performance outcomes.

We capture R&D performance using invention

resonance—the extent to which patents registered

(in the previous five years) by the firm are cited by

subsequent patents.

Our findings make important contributions

to agency and executive compensation literature.

First, we demonstrate the utility of combining the

concept of efficacy with BAM to predict the out-

comes associated with CEO risk bearing. Second,

we provide the insight that CEO risk bearing can

be good for shareholders when the CEO perceives

higher firm efficacy. This suggests that tradi-

tional agency theory’s preoccupation with limit-

ing risk bearing in order to encourage agent risk

taking may not necessarily be in the interests of

the firm’s shareholders. Third, research examin-

ing the relationship between executive pay and

firm performance has generally failed to provide

support for the relationship between equity-based

pay and firm performance that agency theory

predicts (for a review of this literature, see Dalton

etal., 2003). Our study suggests that in order to

understand how CEO compensation influences

performance outcomes, it is necessary to consider

(1) the risk bearing created by CEO compensation

and (2) the CEO’s perception of firm efficacy. This

is useful for both agency scholars and practitio-

ners such as boards of directors and compensation

committees who are battling with the dilemma of

how to compensate their executives to encourage

sound risk taking. This is an issue that has taken

on greater importance in the wake of the global

financial crisis (see Basel Committee on Banking

Supervision, 2009). Finally, we contribute to stud-

ies of the performance effects of R&D and risk

argument is that risk-averse executives may opt

out of risky, potentially value-adding strategic

projects. They are suggested to do so because

their concentrated human and financial capital

(the latter due to enforced equity holdings) cre-

ates significant risk bearing (or wealth at risk of

loss) that reduces their appetite for risk taking.

According to this logic, managerial agents (such as

CEOs) choose less valuable but more conservative

strategic options (Gomez-Mejia, Berrone, Franco-

Santos, 2010). The failure to pursue higher-risk

but higher-value projects is argued to create

agency costs for shareholders due to suboptimal

investment choices and associated inferior per-

formance outcomes (Jensen & Meckling, 1976).

Empirical research, however, has failed to pro-

vide strong support for the relationship between

compensation-induced risk aversion

and poor performance outcomes

(Dalton, Daily, Certo, Roengpitya,

2003). In order to advance this line

of research and develop a stronger

understanding of the circumstances

under which agent risk bearing

could positively or negatively influ-

ence research and development

(R&D) performance, we examine

CEO decision making with regard

to their R&D investment strategy

and the outcomes of these decisions

contingent on the CEO’s perception

of firm efficacy.

Efficacy is defined as “the con-

viction that one can successfully

execute the behavior required”

(Bandura, 1977, p. 193). The rela-

tionship between efficacy and per-

formance has been described as

positive and self-perpetuating; that is, success-

ful performance generates higher efficacy, which

in turn leads to better performance outcomes

(Lindsley, Brass, & Thomas, 1995). For an execu-

tive (the agent) who must make strategic choices

on behalf of the firm, the concept of perceived

firm efficacy has relevance to goal setting, effort,

and the strategic choices they believe can be suc-

cessful (Bandura, 1977; Wood & Bandura, 1989).

For instance, if the agent perceives higher levels

of firm efficacy, they will be likely to set more

challenging strategic goals due to confidence

that these goals can be achieved (Bandura, 1997;

Earley, Northcraft, Lee, & Lituchy, 1990). Higher

perceived firm efficacy is also likely to inspire the

agent to persist in the pursuit of these goals, lead-

ing to superior performance outcomes (Lindsley

et al., 1995). Although the concept of efficacy

has been shown to influence decision making