Firm Risk-taking Research Articles

Equity-Based Compensation for Firm Performance

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.

Taxation and Corporate Risk-Taking

In the recent period of low growth, many governments look for ways to encourage economic activity. Risky investment by firms is an important source of macroeconomic growth. This paper contributes to recent literature on firm risk-taking by exploring if the corporate tax system can provide incentives for firms to undertake risky investment. To do so, we first model that the effect of taxes on firm risk-taking depends on loss offset possibilities. We then confirm our predictions empirically using a large international firm-level dataset. We find that firm risk-taking is positively and significantly related to the length of the tax loss carryback and carryforward periods and that this relation increases with the level of the tax rate. For firms that cannot expect to offset losses, higher tax rates reduce risk-taking. If loss offset is probable, however, corporate tax rates have a significant and positive effect on risk-taking.

The Real Effects of Short Selling on Firm Risk-Taking: Evidence from a Quasi-Natural Experiment in China

The Real Effects of Short Selling on Firm Risk-Taking: Evidence from a Quasi-Natural Experiment in China

Firm Risk-Taking and CEO Visibility

This paper investigates the relationship between CEO visibility and corporate risk-taking. The empirical results show that more visible CEOs tend to take more risk. A one-standard-deviation shock in the CEOs media exposure results in a 6.53% rise in total risk. We further investigate the channels of risk-taking activities and find that more visible CEOs seek more R&D investments. The positive effect of CEO visibility on firm risk policies is clearly of concern to bondholders. Consistent with this view, we report that CEO visibility has a significant negative effect on firm credit ratings. Our results highlight the importance of CEO visibility on a crucial corporate outcome — the extent of corporate risk-taking.

Policy Uncertainty, Political Capital, and Firm Risk-Taking

We document a new channel of corporate political contributions. Firms that are highly sensitive to government policy uncertainty have a stronger incentive to contribute to political candidates, and these firms' risk-taking and performance should be more affected by the gain or loss of a political connection relative to less-sensitive firms. We verify these patterns in the data using a sample of close U.S. congressional elections. We first show that policy-sensitive firms donate more to candidates for elected office than less-sensitive firms. We then show that plausibly exogenous shocks to policy-sensitive firms' political connections produce larger subsequent changes in these firms' investment, leverage, firm value, operating performance, CDS spreads, and option-implied volatility relative to less-sensitive firms. Our results represent the first attempt in the literature to disentangle the effects of policy sensitivity and political connectedness on firms' risk-taking and performance and suggest that many existing results in the political connections literature are driven by policy-sensitive firms.

Globalization, political institutions, financial liberalization, and performance of the insurance industry

This paper investigates the impacts of globalization, political institutions, and financial liberalization on the performance and risk-taking of insurance firms covering 1324 individual firms in 30 selected OECD countries. We find that greater globalization and a stable political institution lead insurance companies to exhibit a better performance—i.e., insurers adjust their strategies while being aware of institutional changes. By contrast, financial liberalization has an inverse impact on insurance company performance. Thus, greater globalization and a stable political environment both drive less risk-taking for insurers. These findings are particularly important to insurance markets’ competitors and national policymakers.

Corporate governance and risk-taking of Chinese firms: The role of board size

The corporate governance reform in China offers an interesting context for investigating the systematic relationship between board size and firm's risky policy choices. Our results indicate that firms with smaller boards experience larger variability in future firm performance. These firms are also associated with higher executive pay-to-performance sensitivity, tend to pursue riskier investment policies, and engage more frequently in earnings management. However, Chinese firms with smaller-sized boards are found to be more conservative in using debt financing. Overall, our Chinese evidence is consistent with the hypothesis that board size has negative impacts on firm risktaking.

The Influence of Board of Directorss Risk Oversight on Risk Management Maturity and Firm Risk-Taking

The Board of Directors’ role in risk oversight has come under increased scrutiny, resulting in shareholder lawsuits, increased regulation, and more extensive disclosure and listing requirements. While theory predicts that Board risk oversight can benefit stakeholders by mitigating risk-related agency conflicts, critics argue that changes in Board practices in response to external pressure may simply be window-dressing. Using both archival and survey data on corporate risk management processes, we examine the influence of Board risk oversight responsibilities and practices on the maturity of the firm’s risk management processes and risk-taking. We find the location of Board risk oversight responsibilities to be a major determinant of Board risk oversight practices, with greater oversight in firms that formally assign responsibilities to the Board as a whole as well as its committees. Supporting the view that risk oversight is conducted for economic reasons, the quality of Board oversight practices has a direct positive relation with the maturity of risk management processes, as well as a significant indirect influence on future stock return volatility and tail risk through the enhanced risk management maturity.

Taxation and Corporate Risk-Taking

We study whether the corporate tax system provides incentives for risky firm investment. We first model the effects of corporate tax rates and tax loss offset rules on firm risk-taking. Testing the theoretical predictions, we find that firm risk-taking is positively related to the length of tax loss periods. This result occurs because the loss rules shift a portion of investment risk to the government, inducing firms to increase their overall level of risk-taking. Moreover, the corporate tax rate has a positive effect on risk-taking for firms that can expect to use their tax losses, and a negative effect for those that cannot. Thus, the effect of taxes on risky investment decisions varies among firms, and its sign hinges on firm-specific expectations of future tax loss recovery.

Employee Inside Debt and Firm Risk-Taking: Evidence from Employee Deposit Programs in Japan

Using a sample of 2104 Japanese firms, we investigate the effect of employee deposits – a form of employee inside debt – on firms’ risk-taking behavior. Our identification strategy utilizes a new law in 2003 that changed the priority of employee deposits in bankruptcy and led to large scale withdrawals of employee deposits. Our results indicate that firms with higher levels of employee deposits have lower total risk, systematic risk, and idiosyncratic risk, engage in less risk-taking investment, and have higher leverage. Our findings suggest that the holding of the company’s debt by its employees can reduce the agency costs of debt.

CEO Option Wealth and Firm Risk-Taking: An Analysis of Multiple Reference Points

The behavioral agency model suggests CEO current wealth affects firm risk-taking. Extending this theory we explore how reference points of CEO current and future wealth (as reflected in respective ...

Employee Inside Debt and Firm Risk-Taking: Evidence from Employee Deposit Program in Japan

Employee Inside Debt and Firm Risk-Taking: Evidence from Employee Deposit Program in Japan

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

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.

The impact of foreign investors on the risk-taking of Japanese firms

Consistent with a bank-centered governance system, Japanese firms exhibit an exceptionally low level of performance variability. The increased involvement of foreign investors motivated by shareholder value is thus likely to have triggered a major shift in their risk-taking behavior. My results confirm this assumption as all standard measures of performance volatility appear to have significantly increased with the level of foreign ownership. Controlling for endogeneity provides higher point estimates supporting anecdotal evidence that foreign investors have targeted firms taking unusually low risk. Overall, the evidence highlights the considerable impact that this category of investors can have on a firm’s decisions and, by consequence, on its performance.

Effects of Culture on Firm Risk-Taking: A Cross-Country and Cross-Industry Analysis

This paper investigates the effects of national culture on firm risk-taking, using a comprehensive dataset covering 50,000 firms in 400 industries in 51 countries. Risk-taking is found to be higher for domestic firms in countries with low uncertainty aversion, low tolerance for hierarchical relationships, and high individualism. Domestic firms in such countries tend to take substantially more risk in industries which are more informationally opaque (e.g. finance, mining, IT). Risk-taking by foreign firms is best explained by the cultural norms of their country of origin. These cultural norms do not proxy for legal constraints, insurance safety nets, or economic development.

Effects of Culture on Firm Risk-Taking: A Cross-Country and Cross-Industry Analysis

This paper investigates the effects of national culture on firm risk-taking, using a comprehensive dataset covering 50,000 firms in 400 industries in 51 countries. Risk-taking is found to be higher for domestic firms in countries with low uncertainty aversion, low tolerance for hierarchical relationships, and high individualism. Domestic firms in such countries tend to take substantially more risk in industries which are more informationally opaque (e.g. finance, mining, IT). Risk-taking by foreign firms is best explained by the cultural norms of their country of origin. These cultural norms do not proxy for legal constraints, insurance safety nets, or economic development.

The Impact of Foreign Investors on the Risk-Taking of Japanese Firms

Consistent with a bank-centered governance system, Japanese firms exhibit an exceptionally low level of performance variability. The increased involvement of foreign investors motivated by shareholder value is thus likely to have triggered a major shift in their risk-taking behavior. My results confirm this hypothesis as the volatility of stock returns, market-to-book value, and profitability is found to have significantly increased with the level of foreign ownership. Controlling for endogeneity provides higher point estimates supporting anecdotal evidence that foreign investors have targeted firms taking unusually low risk. Overall, the evidence highlights the considerable impact that this category of investors can make on a firm’s decisions and, by extension, on its performance.

Board size and firm risk-taking

The main purpose of this paper is to investigate the relevance of board size and firm’s risky policy choices. I find that both the managerial pay to performance sensitivity (delta) and the managerial pay to firm risk sensitivity (vega) are negatively related to board size, suggesting that small boards give CEOs larger incentives and force them to bear more risk than larger boards. While controlling for the effects of managerial compensation schemes on corporate investment policy and financing policy, I find that companies with smaller boards take lower leverage but more risky investment. Finally, after controlling for the effects of financial decisions on overall firm risk, I find that companies with smaller boards are associated with higher future risk. This supports the hypothesis that board size has negative impact on firm’s risk taking. My results are robust to various estimation methods that control for endogeneity and panel dynamics.

The effect of group affiliation on the risk-taking of Japanese firms

This article examines the role of keiretsu (i.e. business group) affiliation on the risk-taking of Japanese firms. We find that total risk, measured by firm-level stock price volatility, is not significantly affected by keiretsu membership. The reason is that affiliated firms are characterized by lower idiosyncratic risk along with higher systematic risk. However, idiosyncratic risk varies across business groups and appears to depend upon the firm's inclination towards its group. In contrast, the higher systematic risk of group affiliates is significant for each keiretsu and every degree of group inclination. Moreover, this result remains after adjusting risk for firm characteristics and industry effects. Hence, the consequence of group affiliation may more accurately be described by higher systematic risk. This result could reflect the weaker competitive position of keiretsu affiliates.

The impact of institutional shareholding on firm income instability risk: Evidence from Finland.

We empirically examine the effect of institutional shareholding on firm risk-taking, narrowly defined. We categorize institutional shareholding into those with both investment and business relationships with the firms in which they own equity stakes (termed pressure-sensitive institutions), and institutions with only an investment relationship with the firm (termed pressure-resistant). The results suggest a differential impact of different institutional investors on firm risk-taking