The financial literature demonstrates two opposite opinions regarding the incentive effects of executive stock options (ESOs) on managerial risk taking (such as innovative activities). The management literature shows that various corporate innovations are associated with different level of risk. By combining the financial theory and the management theory, we posit that ESOs provide managers incentives to undertake corporate innovative activities that are associated with different level of risk. We find that the incentive effects of ESOs are significantly and positively associated with corporate innovative activities, with or without taking into account of the endogeneity. In addition, the risk-taking incentives of ESOs in old economy firms are not as significant as those in new economy firms, somehow explaining why some prior studies question the incentive effects of ESOs on managerial risk taking.
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