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Managerial Stock Compensation and Risky Investment

Keywords: stock options , restricted stock , executive compensation , risky investment.

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Abstract:

This study analyzes the relationship between the mix of CEO equity-based compensation, namely stock options and restricted stock, and firms' risky investment. In general, the theory suggests that long-term compensation aligns CEOs' and shareholders' interests by inducing the managers to undertake risky investment, which has a positive impact on longterm well-being of the firm. However, as my results show, it is important to distinguish between types of awards since they can have different effects on the riskiness of the firm. In this respect, I answer the question how are different types of stock based compensation related to the executives' determination to increase or not the intensity of the firm's risky investment? I find that awarding the CEOs preponderantly with stock options positively affects the firm's level of R&D investment. Conversely, a higher proportion of restricted stock in the CEO's compensation is related to lower investment in (risky) R&D. The inverse relation of causality also holds. Firms that make intensive R&D investments are more likely to award their CEOs with more stock options relative to restricted stock. Overall, the results are consistent with the theoretical prediction, in that the managerial compensation scheme plays an important role in determining the level of R&D investment.

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