The Determinants of Relation between Executive Stock Options and Managerial Risk Taking

This research intends to explore the factor determining the positive relation between executive stock options and managerial risk taking. I firstly investigate the relation between the risk increase of investment project (referred to the risk relative) and a measure of incentive effects of stock options (referred to as the incentive ratio). The evidence shows a positive relation between the risk relative and the incentive ratio, implying that executives undertake more risky projects when their compensation contain a higher proportion of stock options. The causal link between higher option compensation leading to higher risk increase is further examined in terms of firm-specific factors, including firm size, investment opportunity, and managerial discretions (eg., internal liquidity and borrowing capability). The evidence from statistical tests and regression models (OLS and separate-slopes) supports the hypothesis that the relation between option compensation and capital investment risk is determined by firm-specific factors. The results support the hypotheses that the relation of higher option compensation and lagged impact on capital investment risk is constrained by firm-specific factors.