Loss Aversion, Instant Endowment and Risk-Bearing: The Relation between Stock-Based Compensation and Managerial Risk-Seeking Behavior

38 Pages Posted: 7 Dec 2005 Last revised: 5 Dec 2012

See all articles by Kimberly M. Sawers

Kimberly M. Sawers

Seattle Pacific University; University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management

Arnold Wright

Northeastern University - Accounting Group

Valentina L. Zamora

Seattle University - Albers School of Business and Economics

Date Written: November 2006

Abstract

We examine the extent to which the behavioral agency model describes the relation between stock-based compensation and managerial risk-seeking behavior. The behavioral agency model, which incorporates prospect theory, predicts that while managers are more risk-seeking in the loss decision context than in the gain decision context because of loss aversion, such risk-seeking behavior in the loss context is mitigated because managers instantly endow stock-based compensation (i.e., wealth at stake), which increases their risk-bearing. We find that in general, managers are more risk-seeking in the loss context than in the gain context, consistent with prospect theory. Contrary to prospect theory, however, we find that managers endowed with in-the-money stock options are less risk-seeking than managers endowed with at-the-money stock options. This finding is also contrary to agency theory which generally predicts that stock options encourage risk-seeking behavior. We also explore whether managers' subjective valuation of stock options is associated with risk-seeking behavior. We find evidence consistent with managers valuing stock options more than restricted stock of similar objective value. Overall, our results support the propositions based on the behavioral agency model. Moreover, managers appear to consider both risk-bearing as well as subjective valuations of stock-based compensation in their decision-making process. Our findings are important for those using and evaluating the efficacy of different types of stock-based compensation in inducing firm value-increasing risk-seeking behavior.

Keywords: Stock-based compensation, loss aversion, risk-bearing

JEL Classification: M40

Suggested Citation

Sawers, Kimberly M. and Wright, Arnold and Zamora, Valentina L., Loss Aversion, Instant Endowment and Risk-Bearing: The Relation between Stock-Based Compensation and Managerial Risk-Seeking Behavior (November 2006). AAA 2007 Management Accounting Section (MAS) Meeting. Available at SSRN: https://ssrn.com/abstract=864224 or http://dx.doi.org/10.2139/ssrn.864224

Kimberly M. Sawers

Seattle Pacific University ( email )

3307 Third Avenue West
Suite 201
Seattle, WA 98119
United States
206-281-2221 (Phone)
260-281-2733 (Fax)

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management ( email )

900 University Avenue
Riverside, CA 92521
United States
909-787-2418 (Phone)
909-787-3970 (Fax)

Arnold Wright

Northeastern University - Accounting Group ( email )

406 Hayden Hall
United States

Valentina L. Zamora (Contact Author)

Seattle University - Albers School of Business and Economics ( email )

901 12th Avenue
P.O. Box 222000
Seattle, WA 98122-1090
United States
206-296-5703 (Phone)

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