CEO Age, Risk Incentives, and Hedging Strategy

Abstract

This study tests if managerial preferences explain how firms hedge, i.e. how they choose between linear contracts and put options, and if they finance these hedging positions with cash-on-hand or by selling upside (call options). Using hand-collected data on derivative portfolios we characterize hedging strategies in the oil and gas industry. Our main findings are that the likelihood of being a hedger increases with CEO age, and that near-retirement CEOs prefer linear hedging instruments. This suggests that these CEOs place a premium on the additional certainty that comes with linear strategies. The predictions of the managerial risk incentives-theory of hedging strategy, according to which managers with convex compensation schemes would avoid hedging strategies that cap upside potential, find no support in the data. Our findings on managerial preferences add to previous literature emphasizing non-linear exposures and financial status as determinants of hedging strategy.

Keywords: Vega, executive compensation, hedging, options, CEO age

JEL Classification: G30, G32