Executive stock options and systemic risk
48 Pages Posted: 1 May 2020 Last revised: 16 Oct 2021
Date Written: September 1, 2021
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: Suggested Citation