A firm that offers higher equity compensation generally attracts individuals who prefer risk taking.

Question

BlackTom AI · Accepted Answer

The statement to evaluate is: 'A firm that offers higher equity compensation generally attracts individuals who prefer risk taking.'

Option 1: True. Equity compensation (such as stock options or restricted stock) aligns employees’ financial rewards with the company’s performance and future equity value. This type of compensation typically has higher risk and higher potential upside compared to fixed cash pay. People who are more comfortable with risk may be drawn to roles where part of their compensation depends on the company’s stock performance, which can lead to greater upside if the company does well. Additionally, equity upside is often more attractive to individuals willing to accept volatility in exchange for possible long-term gains. Therefore, the link between higher equity compensation and risk-tolerant individuals is a plausible and commonly observed dynamic in many organizations.

Option 2: False. If a firm offers higher equity compensation, it does not automatically attract only risk-averse individuals; in fact, higher equity typically appeals to those who are willing to take on risk for potential greater rewards. Risk-averse individuals may prefer more certain, stable cash compensation and might accept less equity or more guaranteed pay. The assumption in this option ignores the trade-off that equity introduces: ownership-like upside with potential volatility. While not everyone who accepts equity is a risk-taker, the general pattern is that equity-heavy packages attract those who are comfortable with risk and the uncertainties of startup performance or stock price fluctuations.

In summary, the reasoning supports that higher equity compensation tends to draw risk-tolerant candidates because of the potential for larger rewards coupled with greater payoff volatility, whereas the false option mischaracterizes the relationship by implying the opposite risk preference alignment. The nuanced view acknowledges that individual risk tolerance varies, but the overarching trend aligns with the statement.

econ_448_120251_246250 Exercise (02/26/2025)

A firm that offers higher equity compensation generally attracts individuals who prefer risk taking.

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