Does R&D intensity matter in the executive risk incentives and firm risk relationship?

Abstract

Executive risk incentives are widely used to encourage risk-taking in all kinds of firms, especially in research and development (R&D)-intensive firms. Executive risk incentives are commonly measured as the sensitivity of executive equity portfolios to stock return volatility (Vega). Previous studies have established a positive relationship between Vega and various firm risk measures, whereas the impact of R&D on this relationship remains unknown. Using an updated dataset of S&P listed firms from 1993 to 2017, we examine whether and how the relationship between Vega and firm risk varies with R&D investments. We find that a higher Vega encourages executives to take increased total risk in R&D-intensive firms. Specifically, a higher Vega encourages executives to increase total risk by undertaking R&D projects characterized by systematic rather than idiosyncratic risk, while higher systematic risk is associated with lower firm values and higher financing costs. In sum, this study sheds light on a previously unexplored dark side of executive risk incentives in R&D-intensive firms.