CEO option incentives, firm risk-taking and shareholder value: evidence from Australia

Abstract

This study aims at examining the effects of Chief Executive Officers’ (CEOs) option incentives on corporate risk-taking and share market performance based on a panel data set drawn from the 137 largest (by market capitalisation) Australian public firms, for the period 2003 to 2012. The current study also investigates the moderating effects of CEO characteristics on the relationship between corporate environmental responsibility (CER) engagement and corporate financial performance (CFP). The results show that pay-risk sensitivity (vega) has a positive effect on corporate risky financial policy measured by book leverage; while CEO pay-share price sensitivity (delta) has a negative effect on CEOs’ risk-taking behaviour. Further, the study results suggest that out-of or at-the-money options, coupled with longer remaining time to expiration, have substantially positive impact on CEOs’ incentive to take more risks. The results reveal an inverted-U relationship between CEO delta and firm market-based performance measured by Tobin’s Q. In addition, using provisions for site rehabilitation as a new proxy for CER engagement, the results show that short-tenured and high-cash paid CEOs are more likely to use CER engagement as a compensation management tool. The results also document positive association between CER and CFP only in an industry’s cooling-off period.