Large Sample Evidence on the Relation between Stock Option Compensation and Risk Taking

54 Pages Posted: 2 Sep 2003

See all articles by Shivaram Rajgopal

Shivaram Rajgopal

Columbia Business School

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Terry J. Shevlin

University of California-Irvine

Date Written: April 21, 2004

Abstract

A distinctive feature of stock options is that they create incentives for managers to take risks. For a sample of 6,439 CEO-year observations over 1992-1999, we find that risk-taking incentives offered by CEO's stock options (the sensitivity of ESO values to stock return volatility) are statistically associated with greater risk-taking behavior as proxied by one-year ahead stock return volatility. However, the economic magnitude of such option-induced risk taking on the CEO's wealth is relatively modest. Our tests of the performance consequences of option-induced risk taking incentives are specification-dependent and do not exhibit consistent results. Hence, we cannot unambiguously conclude that the increased risk taking results in improved future operating performance.

JEL Classification: J33, M40, M46

Suggested Citation

Rajgopal, Shivaram and Hanlon, Michelle and Shevlin, Terry J., Large Sample Evidence on the Relation between Stock Option Compensation and Risk Taking (April 21, 2004). Available at SSRN: https://ssrn.com/abstract=427260 or http://dx.doi.org/10.2139/ssrn.427260

Shivaram Rajgopal (Contact Author)

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-668
Cambridge, MA 02142
United States
617-253-9849 (Phone)

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

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