Stock Market’s Rise May Be Producing Crop of Very Cautious CEOs, Study of Stock Options Suggests
With the stock market surge over the past several years, executive stock options awarded near the bottom of the market are worth small – or not so small – fortunes. How does this affect the way CEOs run their companies? A hefty increase in options’ paper value may lead to sharp decrease in risk-taking
April 25 2013 by ChiefExecutive.net
In the conventional view, exec options are a one-way street to riches, motivating top managers to embark on risky (some say too risky) strategies to gain Croesus-like wealth. But as a new study in the April issue of the Academy of Management Journal demonstrates, options are mixed gambles that can induce great caution.
Thus, when a CEO is just beginning to accumulate options, the new study finds, he or she is likely to take large risks as “the possibility for growing options wealth weighs more heavily than any risk of losses.” But when those same options have accumulated value, through rises in the company stock price, “the CEO is likely to perceive fewer opportunities for further advancing this wealth, leading to preoccupation with preserving current [stock-option] wealth.”
Complicating matters further is the fact that executives commonly face circumstances in which both motives are in play, where executives hold in-the-money options at the same time that new option grants present opportunities for further wealth. The new research finds that prospective wealth continues to spur risk-taking, though in muted form, even in the presence of the caution induced by the value accretion of older options.
In explanation, the study’s authors, Geoffrey P, Martin of Melbourne Business School, Luis R. Gomez-Mejia of Texas A&M University, and Robert M. Wiseman of Michigan State University, point to executives’ characteristic optimism. In their words, individuals’ tendency to “overweigh low-probability events…is stronger for gains than losses. Said differently, the CEO is more likely to overestimate the probability of earning future gains, leading them to overweigh the prospective wealth associated with strategic risk-taking.”