Termination Risk and Managerial Risk Taking

Abstract

We study the empirical evidence on the relationship between the conditional probability of being fired in the event of poor performance (termination risk) and managerial risk-taking. Previous research has focused on compensation risk only and shown that it has a negative effect on risk-taking. We find that termination risk reduces managerial risk taking similarly. Firms that are more likely to fire their managers for poor performance have significantly lower volatility of stock returns. Further, the positive effect of the convexity of the manager's compensation contract on risk taking is also lower at firms where termination risk is high. A 10% increase in the conditional termination propensity results in 5%-22% reduction in stock return volatility for the median firm in our sample.