Does the market for corporate control influence executive risk-taking incentives? Evidence from takeover vulnerability

Abstract

Purpose This study aims to investigate the role of the market for corporate control as an external governance mechanism and its effect on executive risk-taking incentives. Managers tend to be risk-averse as they are more exposed to idiosyncratic risk, resulting in sub-optimal risk-taking that does not maximize shareholders’ wealth. The takeover market alleviates this problem, inducing managers to take more risk. Therefore, risk-taking incentives inside the firm are less powerful when the outside takeover market is more active. Design/methodology/approach Exploiting a novel measure of takeover vulnerability recently constructed by Cain et al. (2017), the authors explore how takeover vulnerability influences executive risk-taking incentives. Using a large sample of US firms, the authors use fixed-effects regressions, propensity score matching and instrumental variable analysis. Findings Consistent with this study’s hypothesis, a more active takeover market results in less powerful risk-taking incentives. Specifically, a rise in takeover vulnerability by one standard deviation diminishes executive risk-taking incentives by 22.39%, which is an economically meaningful magnitude. Originality/value To the best of the authors’ knowledge, this study is the first to explore the effect of the takeover market on managerial risk-taking incentives, using a novel measure of takeover susceptibility. The authors’ measure of takeover vulnerability is considerably less susceptible to endogeneity, enabling the authors to draw causal inferences with more confidence.

Does board gender diversity weaken or strengthen executive risk-taking incentives?

“…Second, our study extends the literature on managerial risk-taking incentives as we demonstrate that board gender diversity is one of the significant determinants of risk-taking incentives [9][10][11][12][13][14][15][16]. Our results robustly support the arguments underlying the laws and regulations that promote gender diversity.…”

“…Stock options are thus provided to induce managers to engage in more risk-taking. The importance of this branch of research is demonstrated by the existence of a large literature on managerial risk-taking incentives [9][10][11][12][13][14][15][16].…”

Does board gender diversity weaken or strengthen executive risk-taking incentives?

“…Second, our study extends the literature on managerial risk-taking incentives as we demonstrate that board gender diversity is one of the significant determinants of risk-taking incentives [ 9 – 16 ]. Our results robustly support the arguments underlying the laws and regulations that promote gender diversity.…”

“…Stock options are thus provided to induce managers to engage in more risk-taking. The importance of this branch of research is demonstrated by the existence of a large literature on managerial risk-taking incentives [ 9 – 16 ].…”

Does risk matter for executive compensation?

“…The risk premium assumption of the agency theory proposes that the risk premium should be included in the compensation to adjust it to the systematic and unsystematic risks of the firm, especially for the firms that operate in riskier environments. Risk premium will encourage the risk-taking behavior of executives and help firms hire less risk-averse managers (Bolton et al, 2015;Ongsakul et al, 2020). Dee et al (2005) stated that all firms want to hire less risk-averse managers and they compete among themselves for their services, so agents have to be compensated for bearing additional risk, resulting in higher total compensation.…”