Abstract
The paper finds evidence that the equity-based compensation is positively related to firm performance and risk-taking. Both stock price and operating performance as well as firm's risk-taking increase with incentives provided by CEO stock options and stock holdings. The pay-performance sensitivity can explain stock returns better as an additional factor to the Fama-French 3-factor model. When CEOs are compensated with the higher PPS, firms experiences the higher return on asset. The higher pay-volatility sensitivity also leads to the higher risk-taking. While CEO incentive compensation has been perceived mixed on its effectiveness, this study provides support to the equity-based CEO compensation in reducing agency conflicts between CEOs and shareholders.
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