Executive Stock Options as Mixed Gambles: Revisiting the Behavioral Agency Model

Managerial Risk Taking

“…mixed gamble; see Bromiley, 2009Bromiley, , 2010 may help scholars to elucidate conflicting results about the relationship between stock option wealth and managerial risk taking (Balkin, Markman & Gómez-Mejía, 2000;Devers et al, 2008;Larraza-Kintana et al, 2007;Sanders, 2001;Souder & Shaver, 2010). Most studies have relied on the current, historical and social aspiration levels that shape managers' reference points, while very few have focused on future potential outcomes (see Chen, 2008;Martin et al, 2013). In fact, CEO risk preferences are influenced by current wealth that could be lost relative to prospective wealth that could be gained.…”

“…Scholars have detailed how risk bearing, creating risk-averse CEO behaviors, depends on the CEOs' perceived gain or loss situation (Martin, Gómez-Mejía & Wiseman, 2013;Martin, Washburn, Makri, & Gómez-Mejía, 2015), which is often triggered by specific forms of CEO pay plans (e.g., in-the-money options) but not other forms (e.g., out-of-the-money options). For example, Larraza-Kintana et al (2007) find that CEOs seek to protect personal wealth (e.g., derived from in-the-money unexercised stock options) from potential losses and take fewer risks but may also take more risks when faced with employment risk and compensation variability.…”

“…For instance, Martin et al (2013) examine stock options as mixed gambles for CEOs by going beyond pure gambles that offer sole loss (BAM) or sole gain (AT) outcomes. Their findings show that CEOs' perception of a higher level of prospective gains from their stock options tends to offset the negative effect of current wealth on risky strategic choices.…”

"Social Comparison of Top Managers' Relative Equity Wealth, External Environment and Firm Risk Taking"

“…Based on these theoretical assumptions, the original BAM formulation predicts that accumulated CEO wealth generates risk bearing (wealth at-risk) with a negative effect on risk taking. The BAM has been applied to investigate the influence of accumulated values of CEO unexercisable and exercisable options on risk taking (Larraza-Kintana et al, 2007;Devers et al, 2008;Martin et al, 2013) and earnings manipulation (Zhang et al, 2008), and the effect of CEO restricted stock relative to the reference point on research and development (R&D) intensity (Lim, 2014).…”

Nature of Controlling Stake, Manager Shareholding, and R&D Investment

“…Interest convergence hypothesis believes that equity compensation makes manager own shares, managers with "golden handcuffs" naturally form interests alliance with shareholders (Mehran, 1992) [23] and achieve interests convergence (Jense and Meckling, 1976) [4]; equity compensation prompts managers pursuing opportunities more actively, and making high risk investment to get high potential return (Liu and Wen, 2013) [24], equity compensation is a strong tool to connect manager's remuneration and long term profitability (Martin et al, 2013) [25], therefore, equity compensation can motivate mangers to add R&D investment. Managerial entrenchment hypothesis believes that with the increase of manager shareholding ratio, manager control increases, which makes manager be more inclined to empty the companies (Fama and Jensen, 1983) [26]; when managers' shareholding ratio reaches to a certain control over the company, which cannot alleviate the agency problem of insufficient of R&D investment, and can also increase the self-interests behavior of reducing R&D investment.…”