Differential Risk‐taking Implications of Performance Incentives From Stock and Stock Option Holdings

Abstract

We study the risk-taking implications of managerial pay-for-performance incentives (delta) arising from stock and stock options separately in the United States between 1992 and 2017. The current literature assumes that each unit of delta has an equal incentive effect on firm performance. Instead, we show that the risk-reducing effect of performance incentives is more pronounced for executives whose delta comes mostly from stock holdings relative to option holdings. Accordingly, we propose a new measure that takes into account the magnitude of delta from option holdings relative to delta from stock holdings (source ratio). Our results show that risk taking increases as this ratio increases.

CEO prior uncertainty and pay–performance sensitivity

“…I also consider whether differences between insider and outsider CEOs with respect to risk aversion drive the observed differences in first-year PPS between the two groups of CEOs. Previous studies suggest that performance-sensitive pay tends to reduce managerial risk taking (Amihud & Lev, 1981;Savaser & Şişli-Ciamarra, 2017, 2019. Therefore, boards of directors may determine compensation that exhibits less PPS when they compensate a risk-averse CEO in the initial year of a contract.…”