CEO Risk‐Taking Incentives and the Cost of Equity Capital

32 Pages Posted: 22 Oct 2015

See all articles by Yangyang Chen

Yangyang Chen

Hong Kong Polytechnic University - Faculty of Business

Cameron Truong

Monash University; Financial Research Network (FIRN)

Madhu Veeraraghavan

T.A. PAI Management Institute, Finance Area

Date Written: September/October 2015

Abstract

In this paper, we show that the sensitivities of an executive's wealth to changes in stock prices (deltas) decrease the implied cost of equity capital while the sensitivities of an executive's wealth to changes in stock volatility (vegas) increase the implied cost of equity capital. Our findings demonstrate that shareholders understand the risks of firms’ future projects as embedded in executive compensation and price these risks into the cost of equity capital accordingly. The findings have strong implications for optimal executive compensation contract design, project evaluation and cost of capital estimation.

Keywords: executive compensation, deltas, vegas, implied cost of equity capital

Suggested Citation

Chen, Yangyang and Truong, Cameron and Veeraraghavan, Madhu, CEO Risk‐Taking Incentives and the Cost of Equity Capital (September/October 2015). Journal of Business Finance & Accounting, Vol. 42, Issue 7-8, pp. 915-946, 2015. Available at SSRN: https://ssrn.com/abstract=2677427 or http://dx.doi.org/10.1111/jbfa.12126

Yangyang Chen (Contact Author)

Hong Kong Polytechnic University - Faculty of Business ( email )

9/F, Li Ka Shing Tower
The Hong Kong Polytechnic University
Hong Kong, Hung Hom, Kowloon M923
China

Cameron Truong

Monash University ( email )

23 Innovation Walk
Wellington Road
Clayton, Victoria 3800
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Madhu Veeraraghavan

T.A. PAI Management Institute, Finance Area ( email )

Bangalore
Manipal, Karnataka 576104
India
+91-820-2701030 (Phone)

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