Large Sample Evidence on the Relation between Stock Option Compensation and Risk Taking
54 Pages Posted: 2 Sep 2003
Date Written: April 21, 2004
A distinctive feature of stock options is that they create incentives for managers to take risks. For a sample of 6,439 CEO-year observations over 1992-1999, we find that risk-taking incentives offered by CEO's stock options (the sensitivity of ESO values to stock return volatility) are statistically associated with greater risk-taking behavior as proxied by one-year ahead stock return volatility. However, the economic magnitude of such option-induced risk taking on the CEO's wealth is relatively modest. Our tests of the performance consequences of option-induced risk taking incentives are specification-dependent and do not exhibit consistent results. Hence, we cannot unambiguously conclude that the increased risk taking results in improved future operating performance.
JEL Classification: J33, M40, M46
Suggested Citation: Suggested Citation