The latest issue of The Academy of Management Journal includes an interesting article on the impact of CEO stock options on company performance and risk-taking behavior. Here’s a short discussion of the article from one of the authors.
The authors find that “CEO stock options engender high levels of investment outlays and bring about extreme corporate performance (big gains and big losses), suggesting that stock options prompt CEOs to make high-variance bets, not simply larger bets. Finally, we find that option-loaded CEOs deliver more big losses than big gains.”
While stock options do appear to help align the CEO’s incentives with shareholders in motivating greater risk-taking, the finding of larger losses is troubling. The authors speculate that this result comes about “because option-loaded CEOs are focused on upside possibilities, with little concern for downside possibilities.” With options, CEOs benefit from share price increases but don’t pay a penalty for share price drops. The article suggests that grants of restricted stock, rather than options, might help address this problem.
I tend to agree more with the recommendations of the professors than their conclusions about what the data mean. It seems logical that there could be other correlations with risk taking decisions/behavior from senior executives other than the size of stock option grants. For example, companies that grant more stock options tend to be companies that want CEOs to take more risks. A specific type of compensation alone is not the sole motivator or driver of most people's decision making.
ReplyDeleteBruce Brumberg, Editor, www.myStockOptions.com
http://www.mystockoptions.com/