How do Quasi-Random Option Grants Affect CEO Risk-Taking?

Shue, Kelly; Townsend, Richard R.

doi:10.3386/w23091

Cited by 43 publications

(41 citation statements)

References 24 publications

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“…Option compensation therefore creates an incentive to take on more risk (Coles et al 2006). This would lead to increased cash flow volatility, consistent with the findings of Shue and Townsend (2016) who document that a 10% increase in new options granted leads to a 2.8% to 4.2% increase in equity volatility. Further, Campbell et al (2008) show that an increase in equity volatility leads to a significant increase in the firm's predicted longterm failure probability.…”

Section: Background and Hypothesis Developmentsupporting

confidence: 85%

CEO Incentives and Customer‐Supplier Relations

Sanders

Venkateswaran

2017

Production and Operations Management

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This study explores how suppliers adjust their relation‐specific investments (RSI) in response to the different risk‐taking incentives provided by the customer firm to its CEO, during normal and transition periods. We investigate this relation using 17,553 customer–supplier transactions over the 1993–2013 period. We find strong evidence consistent with the risk‐taking argument. Specifically, we find that an increase in the risk‐taking incentives of customer CEOs leads to a decline in suppliers’ RSI in normal periods, but an increase in RSI during transition periods. We employ the FAS‐123R mandate to show that an exogenous reduction in customer CEO's incentive pay increases suppliers’ RSI. We reaffirm the effect with the passage of the Sarbanes–Oxley Act as a secondary quasi‐natural experiment. Finally, we examine several scenarios that either amplify or attenuate the observed relation, based on factors such as financial constraints, distress, growth opportunities, industry competition, and other firm characteristics. Our study contributes to the literature that examines the interplay between corporate policy and product market relationships.

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Section: Background and Hypothesis Developmentsupporting

confidence: 85%

CEO Incentives and Customer‐Supplier Relations

Sanders

Venkateswaran

2017

Production and Operations Management

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“…While the majority of studies suggest that performance-based pay amplifies executive risk taking (e.g., Coles, Daniel, & Naveen, 2006;Rajgopal & Shevlin, 2002;Shue & Townsend, 2017), some studies find opposite results (e.g., Tosun, 2016), or even no relationship (e.g., Hayes et al, 2012;Mehran, 1995;Yermack, 1995). We suggest that partially explaining these somewhat mixed findings is the fact that the effectiveness of performance-based pay in inducing CEO risk taking likely varies depending upon a CEO's attitude toward risk (Wowak & Hambrick, 2010), which is consistent with upper echelon and behavioral finance research.…”

Section: Initial Pay Package's Influence On Ceo Actionsmentioning

confidence: 99%

The influence of CEO risk tolerance on initial pay packages

Graffin

Hubbard

Christensen

et al. 2019

Strategic Management Journal

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Research Summary Based on agency theory, CEOs with greater risk aversion should be given greater incentive‐based compensation to motivate risk taking. We explore whether new CEOs receive initial pay packages that follow this recommendation, or instead receive pay packages that mirror their risk preferences. Rather than finding support for the agency theory perspective, we find that new CEOs are compensated in the way that reinforces their existing risk preferences. Specifically, using a CEO's political orientation to capture relative risk tolerance, we find that conservative‐leaning CEOs receive relatively less performance‐based pay than their liberal‐leaning counterparts. Supplemental analyses suggest this occurs through both a matching and tailoring process, whereby boards offer similar pay packages from CEO‐to‐CEO, but modify them based on differences in risk tolerances. Managerial Summary When designing a new CEO's pay contract, what proportion of the total compensation should be guaranteed versus performance based? To encourage risk taking, most researchers suggest that CEOs with greater risk aversion should have a pay mix that is more heavily weighted toward performance‐based pay. We find that the opposite occurs; new CEOs who are more risk averse tend to receive relatively less performance‐based pay than new CEOs who are more risk tolerant. This appears to occur because CEOs are attracted to firms that offered the prior CEO a pay package that appeals to the new CEO's risk tolerance. Our results also suggest that risk‐seeking CEOs' strategic actions are more strongly influenced by performance‐based pay, while more risk‐averse CEOs seem relatively unaffected by pay mix.

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“…the ratio of debt to equity) or spread costs over multi-year periods in a way that amplifies earnings fluctuations, expecting that fluctuating earnings are likely to induce larger variations in corporate stock values, and that (under the Black-Scholes model) greater stock price variability increases the value of the options (which will be exercised at a time of relatively high prices). Shue and Townsend (2017) found that a 10 percent increase in the CEO's option award was associated with a 2.8 to 4.2 percent rise in the company's stock price volatility.…”

Section: How Top Managers Influence the Pay Systemmentioning

confidence: 99%

Managerial Control and Executive Compensation

Scherer

2019

Rev Ind Organ

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This article analyzes the trajectory and causes of the explosion of American corporate CEOs' compensation relative to that of average workers between 1958 and 2017. The historical data are presented and analyzed in more detail for 2016 and 2017. Important biases in alternative data sets are explored. Alternative hypotheses for the dramatic changes over time are proposed but not resolved. Among other things, the paper investigates the role of tax and other government policy changes and regulation-induced innovations in the organization of executive pay determination.

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How do Quasi-Random Option Grants Affect CEO Risk-Taking?

Cited by 43 publications

References 24 publications

CEO Incentives and Customer‐Supplier Relations

CEO Incentives and Customer‐Supplier Relations

The influence of CEO risk tolerance on initial pay packages

Managerial Control and Executive Compensation

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