from media reports, one might think that the use of stock options to compensate
bank executives was to blame for the financial crisis. Not so, says Kelly Shue
of Chicago Booth, who with Richard Townsend of Dartmouth recently wrote a paper
that found options grants produced only “moderate” effects on executives’ risk
taking and their use of leverage.
paper compared the performance of firms whose grants are based on the value of
options with those whose grants are based on a fixed number. That allowed the
authors to establish a control group and isolate the causal effect between
options and firm performance—something they say has been missing from previous
and Townsend found that a 10 percent increase in the value of new options
granted leads to a 2–6 percent increase in firm equity volatility. And they
concluded that this increase in risk is driven largely by an increase in
also find that an increase in stock options leads to lower dividend growth,
with mixed effects on investment and firm performance,” the authors wrote,
though they concluded that the effect on firms’ performance is usually
and Townsend also found that the effect is greater in the technology and
financial sectors, where executives may have more ability to affect risk in
ways other than through increased leverage.
noted that these effects “are not outrageous,” contrasting them with their
characterization in the media that they produced “extreme risk.” She also
observed that options grants can have a positive impact on companies led by
increases in options may be an effective way to encourage executives to
increase risk-taking,” the authors wrote.
Cat: Business, Markets,Sub: Finance, Strategy, Economics,