Managerial Incentives for Risk-Taking and Internal Capital Allocation
Posted: 25 Aug 2017
Date Written: November 15, 2016
In this study, we show that the option-like structure of equity-based compensation encourages managerial risk-taking and provide new evidence on the way in which CEO’s risk-taking could manifest itself in a multi-segment firm. Our results show that a greater sensitivity of managerial compensation to shareholder wealth — as proxied by CEO’s portfolio vega — leads to greater risk-taking through active capital allocation. We then analyze the impact of risk-taking on shareholder wealth and demonstrate that risk-taking is positively associated with future stock returns. Overall, this article contributes to the literature by providing evidence that equity-based compensation does actually promote the alignment of interests between shareholders and managers.
Keywords: Equity-Based Compensation, Internal Capital Allocation, Risk-Taking
JEL Classification: G30, M12
Suggested Citation: Suggested Citation