CEO Equity Incentive Duration and Expected Crash Risk

Abstract

This study examines the effect of CEO equity incentive duration on firm-specific ex ante crash risk. Using a measure that explicitly accounts for the length of stock and option grant vesting terms (Gopalan et al., 2014), we find that longer CEO equity incentive duration reduces investors’ perceived crash risk, gauged by the steepness of option implied volatility smirk. This finding holds for alternative measures of duration that account for endogeneity, alternative regression specification with lagged independent variables and using an instrumental variable approach. We further find that this negative relation is more salient for firms whose CEOs have a higher level of career concerns and for firms with weaker external monitoring. Additional tests point to financial reporting obfuscation and over-investment as two possible channels through which the duration–crash risk relation operates. Overall, our results suggest that lengthening CEO equity incentive duration discourages managers from bad news hoarding and continuing negative NPV projects, which reduces a firm’s expected crash risk.

Keywords: equity incentive duration; bad news withholding; expected crash risk

JEL Classification: G12, G17, M12, M41, M52