Policy Uncertainty, Corporate Risk-Taking, and CEO Incentives

59 Pages Posted: 19 Sep 2017 Last revised: 20 Dec 2017

See all articles by Mihai Ion

Mihai Ion

University of Arizona - Department of Finance

David Yin

Miami University of Ohio

Date Written: December 19, 2017


Using a news-based index of aggregate policy uncertainty in the US economy, we document a strong negative relation between policy uncertainty and corporate risk-taking. We show that high levels of policy uncertainty are associated with significantly lower future stock return volatility at the firm level. This relation is stronger (more negative) for firms where the CEO has higher delta or less transferable skills, and it is weaker when the CEO has higher vega. Furthermore, when policy uncertainty is high, CEOs sell more own-firm shares and exercise fewer options, firms are more likely to use financial hedging instruments, and they have a higher preference for diversifying mergers. These results are consistent with the hypothesis that CEOs manage the potential effects that policy uncertainty may have on their wealth by adjusting their portfolios' exposure to their own firm and by reducing firm-level risk-taking. Furthermore, our results support the hypothesis that CEO risk-taking incentives are a significant determinant of the effect of policy uncertainty on the real economy.

Keywords: Policy uncertainty, CEO compensation, Risk-taking, Return volatility, CEO delta, CEO vega, Hedging, Diversifying mergers

JEL Classification: G38, G18, G31, G32, G34, D81, J33, M12

Suggested Citation

Ion, Mihai and Yin, David, Policy Uncertainty, Corporate Risk-Taking, and CEO Incentives (December 19, 2017). Available at SSRN: https://ssrn.com/abstract=3039734 or http://dx.doi.org/10.2139/ssrn.3039734

Mihai Ion (Contact Author)

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States
5206210737 (Phone)

David Yin

Miami University of Ohio ( email )

Oxford, OH 45056
United States

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