Managerial Incentives, Options, and Cost-Structure Choices
50 Pages Posted: 5 Jan 2017 Last revised: 23 Nov 2017
Date Written: August 22, 2017
This study explores the relationship between changes in managerial risk-taking incentives and adjustments of firms’ cost structures, particularly the operating leverage (fixed-to-variable cost ratio). We find managers reduce operating leverage by substituting fixed costs with variable costs, mainly in the SG&A and R&D cost components, in response to reductions in option-based compensation following the issuance of FAS 123R. Managers facing a decrease in risk-taking incentives adjust operating leverage downward because high operating leverage intensifies the downside potential of earnings. Overall, we present compelling evidence that managers adjust the cost structure of their firms in response to a reduction in risk-taking incentives.
Keywords: Operating Leverage; Cost Structure; Managerial Incentives; Option Compensation
JEL Classification: M41
Suggested Citation: Suggested Citation