Abstract
Research SummaryWe draw upon applied psychology literature to explore interagent differences in perceived risk to their equity when making strategic risk decisions. Our theory suggests behavioral agency's predicted negative relationship between equity risk bearing and strategic risk taking is contingent upon four personality traits. Our empirical analyses, based on personality profiles of 158 Chief Executive Officers (CEOs) of S&P 1,500 firms in manufacturing industries, indicate the relationship between executive risk bearing and strategic risk taking crosses from negative to positive for high extraversion, greater openness, and low conscientiousness. These findings demonstrate that agency based predictions of CEO risk taking in response to compensation—and board attempts at creating incentive alignment using compensation—are enhanced by integrating insights from personality trait literature.Managerial SummaryWe study the effect of CEO personality on their behavioral responses to stock option pay. Our findings reveal that CEOs that score high on extraversion or openness and low on conscientiousness are less likely to decrease their firm's strategic risk taking as the value of their stock options increases. That is, the tendency of CEOs to become more risk averse in their strategic choices as their option wealth increases (due to loss aversion) is weaker for highly extraverted and more open CEOs, but stronger for more conscientiousness CEOs. Overall, our findings suggest that board of directors need to consider personality traits of their CEOs when designing compensation packages with the intention to align incentives of CEOs with shareholder risk preferences.
Highlights
Behavioral agency scholars have devoted considerable effort to examining risk behaviors incentivized by compensation (e.g., Beatty & Zajac, 1994; Devers, McNamara, Wiseman, & Arrfelt, 2008; Larraza-Kintana, Wiseman, Gomez-Mejia, & Welbourne, 2007; Lim, 2015; Martin, Gomez-Mejia, & Wiseman, 2013; Martin, Washburn, Makri, & Gomez-Mejia, 2015; Pepper & Gore, 2015; Wiseman & Gomez-Mejia, 1998)
Models 2–5 include Chief Executive Officers (CEOs) equity risk bearing variable—i.e., CEO risk bearing associated with stock options—and the personality traits as moderators of the former relationship
We have done so by examining how conscientiousness, neuroticism, extraversion, and openness moderate the relationship between CEO equity risk bearing and strategic risk taking
Summary
Behavioral agency scholars have devoted considerable effort to examining risk behaviors incentivized by compensation (e.g., Beatty & Zajac, 1994; Devers, McNamara, Wiseman, & Arrfelt, 2008; Larraza-Kintana, Wiseman, Gomez-Mejia, & Welbourne, 2007; Lim, 2015; Martin, Gomez-Mejia, & Wiseman, 2013; Martin, Washburn, Makri, & Gomez-Mejia, 2015; Pepper & Gore, 2015; Wiseman & Gomez-Mejia, 1998). An implicit assumption in behavioral agency research has been that CEOs will perceive the same level of risk to a given amount of equity wealth—that is, there is no interagent variation in the salience of loss (gain) firm outcomes that could negatively (positively) impact their equity wealth—in the calculus that precedes strategic risk taking, regardless of individual differences in personality. It follows that extraverted individuals exhibit a bias toward focusing on firm level wins and associated personal equity gains they could reap if things go well, meaning that success—rather than failure—is more salient in their decision making (Hemenover, 2001) With their attention directed toward successful strategic risk taking, the extravert CEO is likely to perceive less risk of failure when making decisions on behalf of the firm; this equates to less perceived threat to their equity wealth. We do not develop a hypothesis for this personality trait
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