CEO Stock Options and Equity Risk Incentives

Melissa A. Williams · Ramesh P. Rao

78 citations0/0 files storedJournal of Business Finance &amp Accounting

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Corporate Finance and Governance Financial Markets and Investment Strategies Risk Management in Financial Firms

Abstract

Abstract: We test the hypothesis that the risk incentive effects of CEO stock option grants motivate managers to take on more risk than they would otherwise. Using a sample of mergers we document that the ratio of post‐ to pre‐merger stock return variance is positively related to the risk incentive effect of CEO stock option compensation but this relationship is conditioned on firm size, with firm size having a moderating effect on the risk incentive effect of stock options. Using a broader time‐series cross‐sectional sample of firms we find a strong positive relationship between CEO risk incentive embedded in the stock options and subsequent equity return volatility. As in the case of the merger sample, this relationship is stronger for smaller firms.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1973Theory of Rational Option Pricing 2005Theory of rational option pricing 1990Performance Pay and Top-Management Incentives 1992The investment opportunity set and corporate financing, dividend, and compensation policies 1985The Determinants of Firms' Hedging Policies 1981Risk Reduction as a Managerial Motive for Conglomerate Mergers 1998Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure

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