Stock Option Awards: Effects on Firm Performance and Risk-Taking after Japan’s Corporate Governance Reforms

Abstract

We empirically investigate the adoption of stock option plans in Japan after the corporate governance reforms of the early 2000s. We examine the determinants of stock option grants, especially focusing on the effects of herding behavior among Japanese firms and the change of accounting treatment of stock option grants. We also investigate the effects of stock option awards on firm performance, using propensity score matching. Then, following Hayes et al. (2012) identification strategy, we provide new evidence on causal relation between managerial incentives and risk-taking. We find that the adoption of stock option plans is more likely in firms that compete with the other firms that have extensively adopted stock option plans in the same industry, indicating that there is a kind of ‘spillover’ effect among those firms. We find that firms that introduce stock option plans generally face liquidity constraint and their option usage declines significantly after the adoption of accounting standards. We also find some evidences that do not support the view that providing incentives for risk-taking is a primary purpose for the use of stock options. This paper provides some new evidence of the adverse implications of stock option plans in the scheme of equity-based compensation.