CEO Risk Incentives and Innovation Premium*

Abstract

We investigate the relationship between CEO risk incentives and the innovation premium (IP) proposed by Forbes. We suggest that compared to traditional proxies of innovation, the IP is a comprehensive measure of a firm's overall innovation and, therefore, can measure innovation effectiveness in broader industries. We find that both option vega and vega‐to‐delta ratio, as measures of CEO risk incentives, have a positive relationship with the IP. Additional tests reveal that the traditional patent‐related outputs are also motivated by CEO risk incentives, but only in the IT industry. Overall, our findings are consistent with (1) the empirical evidence of Coles et al. (2006, Journal of Financial Economics 79, 431) that a higher vega after controlling for delta motivates managers to implement riskier policy choices and (2) the argument (Dittmann et al. 2017, Review of Finance 21, 1805) that the strength of the risk‐taking incentive relative to the performance‐based incentive, the vega‐to‐delta ratio, captures CEO risk‐taking incentives more accurately.