Recent research in neuroeconomics suggests that the same brain areas that generate emotional states are also involved in the processing of information about risk, rewards and punishments. These findings imply that emotions may influence financial decisions in a predictable and parsimonious way. Our evidence suggests that affect – generated either by exogenous manipulations, or endogenously by outcomes of prior actions – indeed matters for financial risk taking, and that it does so by changing preferences as well as the belief formation process. Positive and arousing emotional states such as excitement induce people to take more risk, and to be more confident in their ability to evaluate the available investment options, relative to neutral states, while negative emotions such as anxiety have the opposite effects. Moreover, beliefs are updated in a way that is consistent with the self-preservation motive of maintaining positive affect and avoiding negative affect, by not fully taking into account new information that is at odds with the individuals’ prior choices. Therefore, characteristics of markets, economic policies or organization design that have an impact on emotional brain circuits may influence decision making and affect important outcomes at the individual and aggregate level.

Efficient reward seeking is essential for survival and invariably requires overcoming costs, such as physical effort and delay, which are constantly changing in natural settings. Dopamine transmission has been implicated in decisions weighing the benefits and costs of obtaining a reward, but it is still unclear how dynamically changing effort and delay costs affect dopamine signaling to rewards and related stimuli. Using fast-scan cyclic voltammetry, we examined phasic dopamine release in the nucleus accumbens (NAcc) core and shell during reward-seeking behavior in rats. To manipulate the effort and time needed to earn a reward, we used instrumental tasks in which the response requirements (number of lever presses) were either fixed throughout a behavioral session [fixed ratio (FR)] or systematically increased from trial to trial [progressive ratio (PR)]. Dopamine release evoked by cues denoting reward availability was no different between these conditions, indicating insensitivity to escalating effort or delay costs. In contrast, dopamine release to reward delivery in both the NAcc core and shell increased in PR, but not in FR, sessions. This enhancement of reward-evoked dopamine signaling was also observed in sessions in which the response requirement was fixed but the delay to reward delivery increased, yoked to corresponding trials in PR sessions. These findings suggest that delay, and not effort, was principally responsible for the increased reward evoked dopamine release in PR sessions. Together, these data demonstrate that NAcc dopamine release to rewards and their predictors are dissociable and differentially regulated by the delays conferred under escalating costs.

As human life expectancy continues to rise, financial decisions of aging investors may have an increasing impact on the global economy. In this study, we examined age differences in financial decisions across the adult life span by combining functional neuroimaging with a dynamic financial investment task. During the task, older adults made more suboptimal choices than younger adults when choosing risky assets. This age-related effect was mediated by a neural measure of temporal variability in nucleus accumbens activity. These findings reveal a novel neural mechanism by which aging may disrupt rational financial choice.

Business connections can mitigate agency conflicts by facilitating efficient information transfers, but can also be channels for inefficient favoritism. I analyze these two effects in the mutual fund industry and find that fund directors and advisory firms that manage the funds hire each other preferentially based on the intensity of their past interactions. I do not find evidence that stronger board-advisor ties correspond to better or worse outcomes for fund shareholders. These results are consistent with the notion that the two effects of board-management connections on investor welfare – improved monitoring and increased potential for collusion – balance out in this setting.

Individuals vary in their willingness to take financial risks. Here we show that variants of two genes that regulate dopamine and serotonin neurotransmission and have been previously linked to emotional behavior, anxiety and addiction (5-HTTLPR and DRD4) are significant determinants of risk taking in investment decisions. We find that the 5-HTTLPR s/s allele carriers take 28% less risk than those carrying the s/l or l/l alleles of the gene. DRD4 7-repeat allele carriers take 25% more risk than individuals without the 7-repeat allele. These findings contribute to the emerging literature on the genetic determinants of economic behavior.

In functional magnetic resonance imaging research, nucleus accumbens (NAcc) activation spontaneously increases before financial risk taking. As anticipation of diverse rewards can increase NAcc activation, even incidental reward cues may influence financial risk taking. Using event-related functional magnetic resonance imaging, we predicted and found that anticipation of viewing rewarding stimuli(erotic pictures for 15 heterosexual men) increased financial risk taking, and that this effect was partially mediated by increases in NAcc activation. These results are consistent with the notion that incidental reward cues influence financial risk taking by altering anticipatory affect, and so identify a neuropsychological mechanism that may underlie effective emotional appeals in financial, marketing, and political domains.

Investors systematically deviate from rationality when making financial decisions, yet the mechanisms responsible for these deviations have not been identified. Using event-related fMRI, we examined whether anticipatory neural activity would predict optimal and suboptimal choices in a financial decision-making task. We characterized two types of deviations from the optimal investment strategy of a rational risk-neutral agent as risk-seeking mistakes and risk-aversion mistakes. Nucleus accumbens activation preceded risky choices as well as risk-seeking mistakes, while anterior insula activation preceded riskless choices as well as risk-aversion mistakes. These findings suggest that distinct neural circuits linked to anticipatory affect promote different types of financial choices, and indicate that excessive activation of these circuits may lead to investing mistakes. Thus, consideration of anticipatory neural mechanisms may add predictive power to the rational actor model of economic decision-making.

We develop and test experimentally a theoretical model of the role of self-esteem, generated by private feedback regarding relative performance, on the behavior of agents working on an effort provision task for a flat wage. Agents work harder and expect to rank better when they are told they may learn their ranking, relative to cases when they are told feedback will not be provided. Individuals who learn that they have ranked better than expected decrease their output but expect an even better rank in the future, while those who were told they ranked worse than expected increase their output and at the same time lower their rank expectations going forward. These effects are stronger in earlier rounds of the task, while subjects learn how they compare to their peers. This rank hierarchy is established early on, and remains relatively stable afterwards. Private relative rank information helps create a ratcheting effect in the group’s average output, which is mainly due to the fight for dominance at the top of the hierarchy. Hence, in environments where monetary incentives are weak, moral hazard may be mitigated by providing feedback to agents regarding their relative performance, and by optimally choosing the reference peer group.

This paper considers the empirical stylized facts about CEO turnover in the context of a competitive assignment model in which CEOs and firms form matches based on multiple characteristics. CEOs are viewed as hedonic goods with multidimensional skill bundles. Likewise, firms’ production functions have heterogeneous weights on CEO skills such as firm-specific knowledge, ability to grow sales, and ability to cut costs. There exists a competitive market for CEOs, whose wages are determined analogously to the prices of the hedonic goods in Rosen (1974). In the competitive assignment framework with multiple skill dimensions, both poor relative performance and poor absolute performance are associated with higher rates of CEO turnover even though there is no agency problem or learning. We construct a large dataset describing turnover events during the period 1992-2006, including the type of turnover event, and the characteristics and pay of the replacement manager. We document the salient stylized facts about CEO turnover and replacement apparent in the data, and show that the competitive assignment model is consistent with several of these features.

Financial decision making has a significant genetic component, but it is still unknown
how genes influence choice. Focusing on the serotonin transporter gene, we find
that individuals possessing the short version of the gene invest less in equities, are less
engaged in actively making investments decisions, and have fewer credit lines. Short
gene carriers do not differ from others with respect to cognitive skills, education, or
wealth. However, psychological and brain imaging evidence shows they have higher
levels of neuroticism and suggests that genetically-driven negative emotional reactions
induce the short gene carriers to avoid risky and complex financial choices.

While recent work shows that characteristics of managers influence firm performance, evidence regarding the selection of managers into firms is scarce. This paper uses novel data from the labor market for MBA graduates to understand how these individuals search and compete for jobs. I find that candidates search harder if they have lower ability or worse outside options, the job sought is more valuable, or if firms are more likely to hire. Candidates self-select into positions for which they are better qualified and higher ability types choose to compete for better paying jobs, such as those in the financial industry.

In a competitive managerial labor market, compensation contracts should not depend on public attitudes or social norms regarding income inequality or “fair pay”. In contrast to the standard view of optimal incentive design, we find that public opinion impacts executive compensation. We show that transient negative shocks to the public’s view of executive pay leads to less total CEO pay, and to a shift away from options-based compensation and towards other types of pay. Furthermore, the level and composition of CEO pay also depends on persistent local social norms, such as state-level attitudes towards income inequality, or religiosity. For instance, in states where residents are likely to be more concerned with income inequality, CEO pay is lower across all types of compensation. Therefore, by changing the incentives faced by managers, social norms may influence executive decisions and ultimately, have an effect on real economic outcomes.

We consider a ``managerial optimal'' framework for top executive compensation, where top management sets their own compensation subject to limited entrenchment, instead of the conventional setting where such compensation is set by a board that maximizes firm value. Top management would like to pay themselves as much as possible, but are constrained by the need to ensure sufficient efficiency to avoid a replacement. Shareholders can remove a manager, but only at a cost, and will therefore only do so if the anticipated future value of the manager (given by anticipated future performance net of future compensation) falls short of that of a replacement by this replacement cost. In this setting, observable compensation (salary) and hidden compensation (perks, pet projects, pensions, etc.) serve different roles for management and have different costs, and both are used in equilibrium. We examine the relationship between observable and hidden compensation and other variables in a dynamic model, and derive a number of unique predictions regarding these two types of pay. We then test these implications and find results that generally support the predictions of our model.

This paper analyzes the dynamics of contractual agreements between mutual funds and investment advisors. Using a new dataset that covers U.S. funds between 1993-2002, I find cross-sectional and time-series determinants of advisory contracts. I show that funds rarely experience contractual renegotiation and advisor changes. However, these changes are beneficial: decreases in advisory rates significantly increase subsequent fund performance and net inflows. Separating from an advisor has a significant positive effect on the subsequent ranking of mid-performing funds. These results are puzzling: contractual changes are rare, in spite of their economically significant benefits.