CEO Power, Equity Incentives, and Bank Risk Taking

Abstract

This study examines whether bank risk is a factor influenced by chief executive officer (CEO) power and equity incentives and the interaction between these factors during 2005 through 2009 which marks the unraveling of the financial crisis. CEO power is measured with an index comprised of five underlying variables – CEO duality, a staggered board of directors, the proportion of insiders that sit on the board, the proportion of affiliated board members, and whether the CEO is the founder. We find that firm specific risk is decreasing with CEO power and equity incentives in the form of CEO equity compensation (stock options and restricted stock) and future firm wealth (the value of both exercisable and unexercisable stock options). These findings suggest that when a CEO has more power, they can influence the board’s decision-making to their benefit in reducing risk. Further, when their personal wealth is more tied to firm value, they are less likely to take on high risk projects as these projects could detriment their levels of personal wealth. We also find that CEOs with more power take on higher levels of firm risk when they have greater levels of future firm wealth in the form of unexercisable options. This suggests that powerful CEOs are more likely to take on risk when their personal wealth is tied to long-term firm value as opposed to short-term firm value.

Keywords: Equity compensation, CEO power, banks, risk taking

JEL Classification: G21, G30