Managerial Risk-Shifting Incentives of Option-Based Compensation: Firm Risk, Leverage, and Moneyness
37 Pages Posted: 6 Jun 2006
Date Written: August 10, 2007
Abstract
This paper studies the relation between option-based compensation grants and managerial risk-taking behavior. We examine risk-shifting in stock and asset risk, where the unobservable asset risk is estimated using the volatility restriction method and Moody's KMV algorithm in a Merton (1974) framework. Our empirical results provide support for the hypothesis that managers increase stock risk by increasing both asset risk and leverage. Furthermore, our unique dataset allows us to investigate whether grant date moneyness affects managers' risk-shifting behavior. Consistent with recent theoretical predictions we find that out-of-the-money option grants cause increased risk-taking, while deep-in-the-money option grants reduce managerial risk-taking.
Keywords: Executive Compensation, Incentives, Stock Options, Risk-Shifting, Corporate Finance
JEL Classification: G30, G32, G34, J33
Suggested Citation: Suggested Citation
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