Can Employee Stock Options Contribute to Less Risk-Taking?

Posted: 18 Sep 2019

See all articles by Bruce K. Billings

Bruce K. Billings

Florida State University - Department of Accounting

James Moon

Georgia Institute of Technology - Scheller College of Business

Richard M. Morton

Florida State University - Department of Accounting

Dana Wallace

University of Central Florida - School of Accounting

Date Written: September 3, 2019

Abstract

The executive compensation literature presumes that shareholders offer risk-averse managers stock options to entice them to take on more risk, resulting in riskier investment decisions and thus a greater return on investment. However, recent empirical work challenges this assumption, and theoretical research even argues that high levels of option-based compensation for generally under-diversified managers may actually lead to greater risk aversion. We evaluate the incentive structure of employee stock options by examining the level of R&D investment and the return on that investment conditional on the portfolio “vega”, which captures the sensitivity of option value to stock price volatility. Our results suggest that both investment in R&D and the return on R&D, as measured by future earnings and patent awards, varies concavely with vega. That is, low to moderate levels of vega correspond to increasing investment in and returns on R&D, consistent with vega inducing more profitable investments, but marginal returns decline as vega increases. Collectively, these results, bolstered by several supplemental analyses, suggest that this surprising relation between vega and risky investment is driven by greater risk aversion at higher levels of vega. Overall, our results imply that employee stock options may not always align the incentives of manager and shareholders.

Keywords: Executive Compensation, Managerial Incentives, Risk-taking, research and development

Suggested Citation

Billings, Bruce K. and Moon, James and Morton, Richard M. and Wallace, Dana, Can Employee Stock Options Contribute to Less Risk-Taking? (September 3, 2019). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3450740

Bruce K. Billings (Contact Author)

Florida State University - Department of Accounting ( email )

Rovetta Business Bldg. (RBA)
College of Business
Tallahassee, FL 32306-1110
United States
850-644-7889 (Phone)
850-644-8234 (Fax)

James Moon

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Richard M. Morton

Florida State University - Department of Accounting ( email )

Room No. 421
Tallahassee, FL 32306-8234
United States
850-644-7877 (Phone)

Dana Wallace

University of Central Florida - School of Accounting ( email )

Kenneth G. Dixon School of Accounting
P.O. Box 161400
Orlando, FL 32316-1400
United States

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