Journal
EUROPEAN FINANCIAL MANAGEMENT
Volume 24, Issue 5, Pages 728-774Publisher
WILEY
DOI: 10.1111/eufm.12172
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PropositionDefinition Asset pricing theory postulates that a risk factor correlates with individuals' marginal utility of consumption. Hence, under plausible preferences, individuals should become more risk tolerant given favorable factor returns. We show that this wealth effect predicts a positive association between performance pay and factor returns. Our results support the hypothesized relationship for the market, book-to-market and momentum factors. Factors constructed from bond prices are positively associated to incentives, incrementally to the Fama French factors, but we obtain mixed evidence for higher-order market factors, liquidity factors or factors constructed from national income accounts, including pricing kernels.
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