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

Abstract

We examine how an increase in stock option grants affects CEO risk-taking. The overall net effect of option grants is theoretically ambiguous for risk-averse CEOs. To overcome the endogeneity of option grants, we exploit institutional features of multi- year compensation plans, which generate two distinct types of variation in the timing of when large increases in new at-the-money options are granted. We find that, given average grant levels during our sample period, a 10 percent increase in new options granted leads to a 2.8-4.2 percent increase in equity volatility. This increase in risk is driven largely by increased leverage.

Keywords: Executive compensation, Incentives, Risk-taking, Pay-for-performance

JEL Classification: M52, J33, G32, G34