CEO Risk-taking Incentives Research Articles

Venture capitalist directors and managerial incentives

We examine the effect of board members with venture capital experience (VC directors) on executive incentives at non-venture-backed public firms. VC directors serving on the compensation committee are associated with greater CEO risk-taking incentives (vega) and pay-for-performance sensitivity (delta). These effects are more substantial if VC directors are from highly reputable VC firms. Using the change of direct flight availability to VC hub cities caused by major airline mergers and annual estimates of VC dry powder per industry as instruments, we show that these results are causal. In addition, VC directors are more focused on growth performance goals in CEO compensation contracts. We also document that prior finding of greater research intensity and innovation when VC directors serve on boards of public firms is partly explained by stronger CEO incentives instilled by such directors. Lastly, we find that having VC directors on nominating and/or governance committees is associated with a higher likelihood of forced CEO turnover.

Auditing Standards and Boards’ Decisions about CEO Risk-Taking Incentives: Evidence from the PCAOB’s Proposed Amendment to Auditing Standard No. 12

Auditing Standards and Boards’ Decisions about CEO Risk-Taking Incentives: Evidence from the PCAOB’s Proposed Amendment to Auditing Standard No. 12

Risk-taking incentives and CEOs’ cost-management strategy: evidence from cost-stickiness

ABSTRACT This research investigates the effect of CEO risk-taking incentives on cost stickiness. By analyzing a comprehensive dataset comprising U.S. public firms from 1993 to 2020, we uncover that higher CEO risk-taking incentives are associated with an increased extent of cost stickiness. Moreover, we observe that this relationship is strengthened under specific conditions, namely when financial leverage is lower, corporate governance is weaker, equity market uncertainty is higher, and real investment opportunities are limited. These findings make a valuable contribution to the relevant literature, highlighting the significance of CEO risk-taking as a potential determinant of cost-related decision-making over resource allocation.

Media uncertainty and risk-taking

This study investigates the association between uncertain media tone and risk-taking measures that capture CEO risk-taking incentives, corporate investment, and financial policies. The study predicts that CEOs who attract greater uncertain media tone have more risk-taking incentives. We find a positive association between uncertain media tone and R&D expenditures and financial leverage, and a negative association between uncertain media tone and capital expenditure. Our results are robust to endogeneity concerns and further tests, and demonstrate the importance of uncertainty to executive decision-making. The study documents a potential missing link between uncertain media tone, CEO discretion, and firm risk-taking activities.

When banks become shareholder activists

This study investigates the relationships between bank activism and target firms’ debtholder value, shareholder value, and firm performance. We find that bank activists are more likely to target firms with heavier syndicated loan borrowing and lower credit quality than other shareholder activists. Bank activism events are associated with significantly positive abnormal bond returns, and this effect only exists in the subset of observations where bank shareholder activists possess a loan stake in the target firm. The target firms of bank activism exhibit a significant improvement in credit quality, coupled with decreases in syndicated loan interest rate spreads, crash risk, and CEO risk-taking incentives.

Supply-Chain Concentration and Inefficient Investment

ABSTRACT This paper investigates the influen7ce of supply-chain concentration on inefficient investment. We find that concentrated supply chains significantly foster inefficient investment and distort investments in an under-investing way. It suggests that a concentrated supply-chain base detriments investment efficiency. Nevertheless, the adverse impact is mitigated when switching costs are higher, information environment is more transparent, and CEO risk-taking incentives are higher. We also compare the effects in different types of firms and find that SOEs are less vulnerable to supply-chain concentration in terms of underinvestment. Overall, our study sheds light on the economic implications of supply-chain concentration in emerging markets.

Bank CEO risk-taking incentives and bank lending quality

Bank CEO risk-taking incentives and bank lending quality

Foreign competition and CEO risk-incentive compensation

How do firms modify CEO risk-incentive compensation in response to increased foreign competition? Theoretically we show the answer is ambiguous: increased competition can result in firms either increasing or decreasing the CEO's risk-taking incentives. Empirically using a quasi-natural experiment, tariff cuts resulting from important trade deals, we find evidence that in response to increases in foreign competition firms adjust CEO risk-incentive compensation downwards – a result that is more pronounced for firms with less risk-averse CEOs. These findings suggest that more intense foreign competition results in managers voluntarily taking on more risk, and firms therefore reduce the convexity in managers' compensation.

Venture Capitalist Directors and Managerial Incentives

We examine the effect of board members with venture capital experience (i.e., VC directors) on executive incentives at publicly listed firms. VC directors serving on the compensation committee are associated with greater CEO risk-taking incentives (i.e., vega) and greater pay-for-performance sensitivity (i.e., delta). These effects are more substantial if VC directors are from highly reputable VC firms. Using Regulation S-K requirements to disclose attributes of nominated directors as an instrument, we show that these results are causal. We also document that prior finding of greater research intensity and innovation when VC directors serve on boards of public firms are in part explained by the presence of increased risk-taking incentives of the CEO instilled by such directors. Lastly, we find that having VC directors on nominating and/or governance committees is associated with a higher likelihood of forced CEO turnover.

Independent directors’ legal expertise, bank risk-taking and performance

This study examines whether independent directors’ legal expertise affects bank risk-taking and performance. Using a sample of U.S. banks, we document that the proportion of legal experts among independent directors is negatively related to total risk and systematic risk, suggesting that legal experts are more effective in constraining bank risk-taking activities than other independent directors. In addition, this effect of legal expertise is more pronounced for banks with high CEO risk-taking incentives. We also find that independent directors’ legal expertise is negatively associated with Tobin’s q, in contrast to the notion that legal expertise can enhance bank performance. Overall, our findings suggest that legal experts among independent directors play a more effective role in the oversight of bank risk-taking than other directors; however, the mitigation of risk-taking does not necessarily improve bank performance.

Monitoring Institutional Ownership and Corporate Innovation

In this study, we examine the role of monitoring institutional investors in firm innovation. Following Fich, Harford and Tran (2015), we define monitoring institutions as those whose holding value in a firm is among the top 10% of holdings in the institution’s portfolio. We document a positive effect of monitoring institutional ownership on firm innovation after controlling for traditional measures of institutional ownership. The positive effect is more pronounced when monitoring institutions are more diversified. We further find that monitoring institutions enhance firm innovation by: (1) increasing failure tolerance and CEO risk-taking incentives, and (2) reducing intense board monitoring, managerial career concerns, and diversion of corporate resources. Overall, the evidence shows that monitoring institutions are instrumental in promoting firm innovation.

CEO risk-taking incentives and corporate social responsibility

We examine how firms adjust CEO risk-taking incentives in response to risk environments associated with their corporate social responsibility (CSR) standing. We find strong evidence that as a firm's CSR status improves (declines), increasing (decreasing) its risk-taking capacity, the firm responds by adjusting compensation contracts to increase (decrease) CEO risk-taking incentives (Vega). One channel of the adjustment is through stock option grants. Further analyses indicate that the positive CSR-Vega association is stronger in firms with better corporate governance and in industries where riskiness is more important. Our evidence indicates that firms are not passive in response to changes in CSR status and firm risk.

Intangible intensity and stock price crash risk

We evaluate the association between intangible intensity and stock price crash risk for U.S. listed firms from 1983 to 2017. The results show that intangible-intensive firms are associated with high crash risk. The decomposition of intangible intensity identifies goodwill as the driving force and documents its predictability for future impairment events. Moreover, intangible intensity affects stock price crash risk mainly through increased information asymmetry, and the positive association increases with stock price synchronicity, CEO risk-taking incentives, and shareholder litigation risk. Our findings demonstrate the fragility of intangible assets and provide implications for financial regulation and portfolio management.

Corporate Social Responsibility and Bond Volatility

This paper examines the effects of corporate social performance on bond volatility. We find a strong positive relationship between social performance and volatility after controlling for bond characteristics and firm fundamentals. The empirical results show that the effect concentrates on social performance strengths and is robust to alternative measures, alternative sample periods and endogeneity controls. The main mechanism through which CSR spending affects bond market uncertainty is overinvestment inasmuch as social performance-related spending raises bond investor concerns. In addition, we find that the effect is more pronounced for firms with higher CEO risk-taking incentives and more active tax avoidance practices.

Trademark Protection and CEO Risk-taking Incentives

Trademark Protection and CEO Risk-taking Incentives

Corporate Social Responsibility and CEO Risk-Taking Incentives

In this paper, we explore how firms adjust CEO compensation incentives in response to corporate social responsibility (CSR) standing. Specifically, we focus on the effect of CSR standing on CEO’s risk-taking incentives. We hypothesize that because firms possessing better social performance generate insurance-like moral capital that protects managers from market discipline, risk averse managers tend to take less risk than is optimal for shareholders. Firms should respond to this agency problem by offering greater risk-taking incentives to managers. Employing a large sample of the US firms from 1992 to 2010, we find strong empirical evidence to support our hypothesis. Indeed, CSR standing is positively related to CEO pay-risk sensitivity (Vega), and this association is driven by CSR strengths rather than CSR concerns. Further, we provide evidence that firm overall risk and idiosyncratic risk negatively moderate the association between CSR and Vega.

Intangible Intensity and Stock Price Crash Risk

We evaluate the association between intangible intensity and stock price crash risk for U.S. listed firms from 1983 to 2017. The results show that intangible-intensive firms are associated with high crash risk. The decomposition of intangible intensity identifies goodwill as the driving force and documents its predictability for future impairment events. Moreover, intangible intensity affects stock price crash risk mainly through increased information asymmetry, and the positive association increases with stock price synchronicity, CEO risk-taking incentives, and shareholder litigation risk. Our findings demonstrate the fragility of intangible assets and provide implications for financial regulation and portfolio management.

Risk Can Be Good: The Tradeoff Between Agency Conflicts, CEO Risk-Taking Incentives, and Credit Risk

We explore the trade-off between managerial risk-taking incentives and firm-level credit risk. Assuming that risk-taking incentives do not increase firm value, risk-taking incentives can lead to an asset substitution problem that hurts creditors. However, it is possible that risk-taking incentives will increase firm value, making creditors better off. Empirically, we find that credit rating agencies and credit default swap investors award more favorable credit ratings and credit default swap spreads, respectively, to firms that incentivize managers to engage in greater risk-taking behaviors. Consistent with recent theoretical research, we document a positive relation between managerial risk-taking incentives and firms' market value of assets. In addition, in a difference-in-differences specification, we find that increased risk-taking incentives lead to lower credit risk. Moreover, we document an incremental association between risk-taking incentives and credit risk for firms less likely to exhibit risk-shifting. Our paper is the first to empirically examine the trade-offs predicted by compensation theory from a creditor's perspective. Therefore, we extend prior literature by highlighting that creditors can benefit from risk-taking, suggesting that CEO risk-taking incentives can make both shareholders and bondholders better off. In the process, our results help reconcile conflicting views in the literature. In addition, we provide the first evidence on which firms benefit the most from risk-taking incentives: financially constrained firms. Collectively, our findings refine our understanding of why firms encourage managers to engage in risk-taking behavior.

CEO Compensation at Financial Firms

We examine whether risk-taking among the largest financial firms in the U.S. is related to CEO equity incentives before the 2008 financial crisis. Using data on U.S. Federal Reserve emergency loans provided to these firms, we find that the amount of emergency loans and total days the loans are outstanding are increasing in pre-crisis CEO risk-taking incentives – “vega”. Our results are robust to accounting for endogeneity in CEO equity incentives and selection of financial firms into emergency loan programs. We also rule out the possibility that our results are driven by a financial firm’s funding base, its complexity, or CEO overconfidence. We conclude that equity incentives (vega) embedded in CEO compensation contracts were positively associated with risk-taking in financial firms which resulted in potential solvency problems. We also find some evidence, although somewhat weaker, that higher incentive alignment (“delta”) mitigated such problems in those financial firms.

The Dark Side of Bank CEO Risk-taking Incentives: Evidence from Bank Lending Decisions

This paper investigates how bank CEO risk-taking incentives influence bank lending decisions. Consistent with the existing CEO incentive literature, we find that CEOs with higher risk-taking incentives (vega) tend to relax their lending standards in bank loan contracts to pursue higher compensation. We find that banks with a high vega tend to charge a significantly lower loan spread, demand fewer loan covenants, and have lower probability to seek collateral. Results become weaker when banks have strong corporate governance mechanisms, supporting the proposition that high CEO risk-taking incentives may create an agency problem between a bank manager and shareholders.