Does stock option-based executive compensation induce risk-taking? An analysis of the banking industry |
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| Institution: | 1. W.P. Carey School of Business, Arizona State University, Tempe, AZ 85287, USA;2. Robert and Maria Lowden Chair of Finance, Neeley School of Business, Texas Christian University, Fort Worth, TX 76129, USA;3. Samuel S. Stewart, Jr. Presidential Chair in Business, David Eccles School of Business, University of Utah, Salt Lake City, UT 84112, USA;4. Neeley School of Business, Texas Christian University, Fort Worth, TX 76129, USA;2. Lehigh University, Perella Department of Finance, 621 Taylor Street, Bethlehem, PA 18015, United States |
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| Abstract: | We investigate the relation between option-based executive compensation and market measures of risk for a sample of commercial banks during the period of 1992–2000. We show that following deregulation, banks have increasingly employed stock option-based compensation. As a result, the structure of executive compensation induces risk-taking, and the stock of option-based wealth also induces risk-taking. The results are robust across alternative risk measures, statistical methodologies, and model specifications. Overall, our results support a management risk-taking hypothesis over a managerial risk aversion hypothesis. Our results have important implications for regulators in monitoring the risk levels of banks. |
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