Idiosyncratic Risk, Risk-Taking Incentives and the Relation Between Managerial Ownership and Firm Value
European Journal of Operational Research, Forthcoming
59 Pages Posted: 21 Jul 2012 Last revised: 2 Jul 2020
Date Written: 2019
Abstract
In addition to its well-documented alignment effect, managerial ownership may also value-destroying effects by shifting risk to managers and encouraging risk-substitution; that is, managers with relatively undiversified personal portfolios tend to pass up profitable projects with high idiosyncratic (firm-specific) risk in favor of less-profitable projects that have greater aggregate (market) risk. Using parametric and semi-parametric estimation methods, we examine how managerial ownership influences firm value in light of the trade-off between the alignment and the risk-substitution effects. We find that risk-substitution offsets the alignment effect of managerial ownership in firms that are exposed to severe risk-substitution problems, leading to a weak (or non-existent) association between managerial ownership and firm value. Our findings also suggest that semi-parametric methods may prove useful for future studies aiming at capturing nonlinear features in the data.
Keywords: Idiosyncratic Risk, Risk-substitution, Managerial Ownership, Firm Value, Semi-parametric Estimation
JEL Classification: G3, G32
Suggested Citation: Suggested Citation