More Manipulation, Less Risk Taking?

26 Pages Posted: 6 Jun 2014

See all articles by Sharon Hannes

Sharon Hannes

Tel Aviv University - Buchmann Faculty of Law

Avraham D. Tabbach

Tel Aviv University

Date Written: June 5, 2014

Abstract

Executive stock options are a dominant component of managers pay in the United States. This common compensation feature entails two perverse side effects: driving managers to engage in manipulative practices, and generating excessive risk-taking. Tellingly, some scholars blame the first side effect for the wave of Enron-style fraud in 2001-2002 and the second for the 2007-2010 financial crisis. To date, however, no one has investigated the interaction between these two types of adverse incentives, for manipulation and risk-taking. In this paper, we study the effects of manipulation practices on risk-taking decisions of managers holding large amounts of stock options. We first show that sufficient manipulation restrains excessive risk-taking but it does not impede managers from taking beneficially risky projects. We then show that mild levels of manipulation have complex effects on managers’ preference for risk taking, but they too tend to decrease risk taking. Our analysis suggests that when regulation improves disclosure and impedes manipulative practices, excessive risk taking may erupt. Policy-wise, we recommend that anti-manipulative regulatory policies be accompanied by measures designed to prevent excessive risk taking.

Keywords: Financial Crisis, Stock Options, Manipulation, Risk-Taking

JEL Classification: G3, K2

Suggested Citation

Hannes, Sharon and Tabbach, Avraham D., More Manipulation, Less Risk Taking? (June 5, 2014). Available at SSRN: https://ssrn.com/abstract=2446594 or http://dx.doi.org/10.2139/ssrn.2446594

Sharon Hannes (Contact Author)

Tel Aviv University - Buchmann Faculty of Law ( email )

Ramat Aviv
Tel Aviv 69978, IL
Israel

Avraham D. Tabbach

Tel Aviv University ( email )

Ramat Aviv
Tel Aviv 69978, IL
Israel

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