The Effect of Executive Stock Options on Corporate Innovative Activities

Abstract

This study investigates whether the implicit optionality of executive stock options (ESOs) induce managers to undertake innovative activities associated with various types of risk. We find ESO risk incentive (vega) to be positively correlated with all types of corporate innovations. We also find greater ESO risk incentive effects for the product‐related innovative activities that are associated more with systematic risk than idiosyncratic risk. Finally, we document the following pecking order for the ESO risk incentive effects: improved product, new product, alliance, and new research and development. Our results suggest that executives have more incentive to invest in projects with higher systematic risk.

Innovation and Price Informativeness

“…We include CEO overconfidence because Galasso and Simcoe () find that overconfident CEOs are more productive in innovation. We also control for pay‐performance sensitivity and pay‐volatility sensitivity since CEO compensation structure can impact innovation outcomes (Chen, Chen, and Chih‐Kang, ). Detailed variable definitions are available in Appendix A.…”

Crowding‐in and crowding‐out effects of corporate philanthropy on R&D investment

“…According to resource constraint theory, for any firm, the available resources are limited, and thus, decision-makers face the challenge of allocating resources to CP and R&D activities, inevitably generating competition for resources. Different from CP, R&D investment not only requires a lot of resources (Chen et al, 2014) but also carries a high risk of failure (Tian & Wang, 2014) and uncertain benefits (Chen et al, 2016). R&D investment is a business activity that is beneficial for firms' long-term gains but places greater pressure on short-term operating performance (Lee & Wu, 2016).…”

CEO risk-taking incentives and corporate social responsibility

“…Options are argued to encourage risk-taking as their convex payoffs reward upside outcomes while having less or no downside effects. Prior research shows a significantly positive relation between Vega, the sensitivity of CEO wealth to stock return volatility, and measures of firm risk (e.g., Guay, 1999 ; Coles et al, 2006 ; Armstrong and Vashishtha, 2012 ; Chen et al, 2014 ) and suggest that Vega is an effective tool for firms to encourage their executives to take risks. The literature finds a causal relation by studying exogenous shocks to Vega (e.g., Chava and Purnanandam, 2010 ; Gormley et al, 2013 ; Bakke et al, 2016 ; Shue and Townsend, 2017 ).…”