Leverage and Growth: Effect of Stock Options

58 Pages Posted: 4 Nov 2011

See all articles by Bill B. Francis

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Zenu Sharma

St John's University; Rensselaer Polytechnic Institute

Date Written: October 5, 2011


​This paper investigates the potential effects of stock options on managers’ investment decisions and therefore on a firm’s growth or, alternatively, on its leverage-growth relationship. To structure the analysis addressing this issue, the paper utilizes a framework establishing a negative relationship between leverage and the firm’s growth. However, in contrast to some of the existing results, the empirical analysis of manufacturing firms in this paper shows that the negative relationship between leverage and growth has changed significantly. Primarily this paper documents that, as options based compensation in manager’s portfolio increases, the negative effect of leverage on growth disappears. The paper argues that this is an important finding, because it implies that when managers are compensated with options debt ceases to pre-commit managers. On addressing the potential endogeneity problem between leverage, growth and compensation the paper finds that option delta instead of book leverage negatively affects growth, and that book leverage and option delta are inversely related. Finally, the paper also examines the effect of corporate governance on the relationship between leverage, incentives and the firm’s growth and finds that leverage is negatively related to growth only in poorly governed firms.

Keywords: leverage, stock options, compensation schemes, corporate governance

JEL Classification: G32, G34, C21

Suggested Citation

Francis, Bill B. and Hasan, Iftekhar and Sharma, Zenu, Leverage and Growth: Effect of Stock Options (October 5, 2011). Bank of Finland Research Discussion Paper No. 19/2011, Available at SSRN: https://ssrn.com/abstract=1954559 or http://dx.doi.org/10.2139/ssrn.1954559

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management ( email )

Troy, NY 12180
United States

Iftekhar Hasan (Contact Author)

Fordham University ( email )

NEW YORK, NY 10023
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006

Zenu Sharma

St John's University ( email )

8000 Utopia Pkwy
Queens, NY 11439
United States
7189905496 (Phone)

Rensselaer Polytechnic Institute ( email )

Troy, NY 12180
United States

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