Executive Stock Options, Differential Risk-Taking Incentives, and Firm Value

By Christopher S. Armstrong, Rahul Vashishtha. 2012

414 citations recorded by the source corpus.

The sensitivity of stock options' payoff to return volatility, or vega, provides risk-averse CEOs with an incentive to increase their firms' risk more by increasing systematic rather than idiosyncratic risk. This effect manifests because any increase in the firm's systematic risk can be hedged by a CEO who can trade the market portfolio. Consistent with this prediction, we find that vega gives CEOs incentives to increase their firms' total risk by increasing systematic risk but not idiosyncratic risk. Collectively, our results suggest that stock options might not always encourage managers to pursue projects that are primarily characterized by idiosyncratic risk when projects with systematic risk are available as an alternative.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/ecfff057b728e23050e51b9dc11f245aa2dc794c

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Citations in the corpus

Gender Differences in Financial Reporting Decision-Making: Evidence from Accounting Conservatism (2015, neutral): “Armstrong and Vashishtha (2012) find that executives’ risk incentives are significantly positively related to firms’ systematic risk.”
Corporate Social Responsibility and CEO Risk-Taking Incentives (2016, positive): “Many studies show a significantly positive relation between Vega and measures of firm risk (e.g., Guay, 1999; Coles, Daniel, and Naveen, 2006; Armstrong and Vashishtha, 2012), suggesting that Vega is an effective tool for firms to encourage”
Firm Life Cycle, Corporate Risk Taking, and Investor Sentiment (2017, neutral): “A positive association between executive compensation incentives and managerial risk-taking has also been reported by other studies (e.g., Coles et al. 2006; Armstrong and Vashishtha, 2012; Shen and Zhang, 2013) although such incentives affect future performance adversely (Shen and Zhang, 2013).”
Corporate Governance, Incentives, and Tax Avoidance (2015, background): “6 Armstrong and Vashishtha (2012) develop a numerical example that shows that although equity portfolio vega provides risk-averse CEOs with incentives to take both systematic and idiosyncratic risk, the incentive to take”
CEO Compensation and Corporate Risk: Evidence from a Natural Experiment (2013, positive): “A similar concern applies to Armstrong and Vashishtha (2012) and Shue and Townsend (2013), who attempt to resolve the endogeneity problem using instrumental variables.(5) Other recent work attempts to overcome the challenge by analyzing firms' risk-taking following new accounting rules that reduced ”
The Relation between Equity Incentives and Misreporting: The Role of Risk-Taking Incentives (2013, background): “acknowledge the different theoretical predictions regarding the relationship between delta, vega, and firm risk, and account for them separately in their empirical specifications (e.g., Coles, Daniel and Naveen, 2006; Low, 2009; Armstrong and Vashishtha, 2012).”