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

For all CEOs, the professors calculated the current paper value of stock options (averaging $13.5 million) from the number of options held at each year’s end multiplied by the amount the options were in the money. They calculated prospective value (averaging $18 million) from four factors — the number of options CEOs held, their expiration date, the price of the underlying stock, and the average yearly rise in the Dow industrial index (6.8%) during the 14 years covered by the study. Hedging was gauged from the availability of put options covering companies in the sample and the volume of trading in these instruments.

Among the findings:

  • An increase of one standard deviation in CEOs’ prospective stock-option haul (say, from the sample’s mean of $18 million to $46 million) was associated with a 33% increase in strategic risk-taking.
  • In sharp contrast, an increase of one S.D. in CEOs’ current stock-option haul (say, from the sample’s mean of $13.5 million to $42.5 million) was associated with a 18% decrease in risk-taking.
  • An increase of one S.D. in both prospective and current stock-option wealth was associated with a 5% increase in risk-taking.
  • Being able to buy put options as a hedge boosted by 30% the positive effect of prospective stock-option value on CEO risk-taking.

In sum, when company-granted stock options are a major part of their compensation, CEOs are most likely to take strategic risks when they are relatively new to their position, are able to hedge their gains, and have shown promise without yet having gained the total confidence of their directors. In the words of Wiseman, “A little bit of vulnerability, a pinch of financial hedging, and ample promise of bigger gains ahead.”