Are the Fama French factors treated as risk? Evidence from CEO compensation

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.