Managerial incentives for risk-taking and internal capital allocation

Abstract

In this study, we show that the option-like structure of equity-based compensation encourages managerial risk-taking and provide new evidence on the way in which CEO’s risk-taking could manifest itself in a multi-segment firm. Our results show that a greater sensitivity of managerial compensation to shareholder wealth—as proxied by CEO’s portfolio vega—leads to greater risk-taking through active capital allocation. We then analyze the impact of risk-taking on shareholder wealth and demonstrate that risk-taking is positively associated with future stock returns. Overall, this article contributes to the literature by providing evidence that equity-based compensation does actually promote the alignment of interests between shareholders and managers.

Evidence of governance arbitrage by private equity sponsors

“…Idiosyncratic risk, Sigma, is significantly associated with an increasing shortfall. This result is similar to Casavecchia and Suh ().…”

“…() that some mechanisms are complementary and compatible. As in the literature, I find that incentives are an important mechanism (Casavecchia and Suh, ) but that this importance varies by a firm's setting (e.g. information environment).…”