Do Stock Options Encourage Managers to Take Risk?

Abstract

The empirical results derived from our fixed effects model provide no support for a linkage between a CEO's stock option grant and future firm risk. We find, using the panel corrected error term methods (PCSE) that control for the heteroscedasticity and autocorrelation, that current period stock option awards do have a positive effect on future firm risk. From the PCSE model we also find that the current year's market risk premium has a statistically significant negative effect on firm risk. The paper shows that changes in an executive's base salary can be used to mitigate the influence that stock option grants have on future firm risk. Of particular importance to shareholders is our finding that the firm's future risk profile increases with CEO tenure, suggesting that CEOs adopt more aggressive strategies over time.