Executive stock options and systemic risk

48 Pages Posted: 1 May 2020 Last revised: 16 Oct 2021

See all articles by Chris Armstrong

Chris Armstrong

Stanford Graduate School of Business

Allison Nicoletti

University of Pennsylvania - Accounting Department

Frank Zhou

University of Pennsylvania - The Wharton School

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2021

Abstract

Employing a novel control function regression method that accounts for the endogenous matching of banks and executives, we find that equity portfolio vega, the sensitivity of executives' equity portfolio value to their firms' stock return volatility, leads to systemic risk that manifests during subsequent economic contractions but not expansions. We further find that vega encourages systemically risky policies, including maintaining lower common equity Tier 1 capital ratios, relying on more run-prone debt financing, and making more procyclical investments. Collectively, our evidence suggests that executives' incentive-compensation contracts promote systemic risk-taking through banks' lending, investing, and financing practices.

Keywords: Executive compensation; Equity incentives; Systemic risk; Business cycles

JEL Classification: E32, G21, G32, J33

Suggested Citation

Armstrong, Chris S. and Nicoletti, Allison and Zhou, Frank, Executive stock options and systemic risk (September 1, 2021). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3689960 or http://dx.doi.org/10.2139/ssrn.3689960

Chris S. Armstrong

Stanford Graduate School of Business ( email )

655 Knight Way
E316
Stanford, CA 94305-5015
United States

HOME PAGE: http://https://www.gsb.stanford.edu/faculty-research/faculty/christopher-s-armstrong

Allison Nicoletti

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Frank Zhou (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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