Does Greater Risk-Bearing in Stock Option Compensation Reduce the Influence of Problem Framing On Managerial Risk-Taking Behavior?

Abstract

We examine the extent to which the behavioral agency model reflects the relation between greater risk-bearing in stock option compensation and managerial risk-taking. The behavioral agency model predicts that managers with greater wealth at stake will avoid risky projects that threaten their wealth. This greater risk-bearing effect moderates the problem-framing effect, which predicts that loss-averse managers will be more (less) risk-taking when choosing among loss (gain) projects. Using a 2 × 2 between-subjects experiment with 108 M.B.A. students acting as managers, we find that managers are more risk-taking in the loss context than in the gain context when they have at-the-money stock options but not when they have wealth at stake through in-the-money stock options. Further, we find that managers with in-the-money stock options are less risk-taking than managers with at-the-money stock options in the loss context. These findings support the behavioral agency model prediction that greater risk-bearing in stock option compensation (moving from at-the-money stock options to in-the-money stock options) reduces the problem framing effect on risk-taking behavior, particularly when the firm faces a loss decision context. Our results point to the importance of considering the implications of risk-bearing in stock option compensation for managers choosing risky projects that affect firm value.

CEO power and corporate risk: The impact of market competition and corporate governance

“…Specifically, decision makers tend to exhibit risk‐averse preferences when framing decisions as gains and risk‐seeking preferences when framing decisions as losses (Wiseman & Gomez‐Mejia, ; Zona, ). Sawers, Wright, and Zamora () find that managers are more risk‐seeking in the loss context than in the gain context.…”

The Effects of Risk Preference and Loss Aversion on Individual Behavior Under Bonus, Penalty, and Combined Contract Frames

“…Framing is well established as an important consideration for a number of decisions in accounting. For instance, prior research demonstrates the role of framing on risk-taking (Moreno et al 2002;Sawers et al 2011), managerial decision-making (Lipe 1993;Sullivan and Kida 1995), tax compliance (Christian and Gupta 1994), and acceptance among audit-client dyads (Cohen and Trompeter 1998). Luft (1994) studies the role of decision-framing on preferences for bonus and penalty contracts.…”

Managerial Creativity: The Roles of Dynamic Capabilities and Risk Preferences

“…While the literature agrees that difficult targets imply pay‐for‐performance (Gómez‐Mejía and Balkin, ), we contend that tasks with high target setting are likely to be complex and provide pay‐for‐performance. First, compensation design has been extensively investigated to explain various behaviors of managers, such as risk taking, performance, creativity, and innovation (Sawers et al ., ; Ederer and Manso, ). Having different types of compensation might influence managers' motivation to search for and identify various solutions, which impacts their sensing capabilities.…”