CEO Stock Options and Equity Risk Incentives

19 Pages Posted: 15 Apr 2006

See all articles by Melissa A. Williams

Melissa A. Williams

University of Houston, Clear Lake - School of Business and Public Administration

Ramesh P. Rao

Oklahoma State University - Stillwater - Spears School of Business - Department of Finance

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Abstract

We test the hypothesis that the risk incentive effects of CEO stock option grants motivate managers to take on more risk than they would otherwise. Using a sample of mergers we document that the ratio of post- to pre-merger stock return variance is positively related to the risk incentive effect of CEO stock option compensation but this relationship is conditioned on firm size, with firm size having a moderating effect on the risk incentive effect of stock options. Using a broader time-series cross-sectional sample of firms we find a strong positive relationship between CEO risk incentive embedded in the stock options and subsequent equity return volatility. As in the case of the merger sample, this relationship is stronger for smaller firms.

Suggested Citation

Williams, Melissa A. and Rao, Ramesh P., CEO Stock Options and Equity Risk Incentives. Journal of Business Finance & Accounting, Vol. 33, No. 1-2, pp. 26-44, January/March 2006. Available at SSRN: https://ssrn.com/abstract=886398 or http://dx.doi.org/10.1111/j.1468-5957.2006.01357.x

Melissa A. Williams (Contact Author)

University of Houston, Clear Lake - School of Business and Public Administration ( email )

Houston, TX 77058
United States
(281) 283-3211 (Phone)
(281) 283-3951 (Fax)

Ramesh P. Rao

Oklahoma State University - Stillwater - Spears School of Business - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States
405-744-1385 (Phone)
405-744-5180 (Fax)

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