CEO Risk Incentives and Firm Performance Following R&D Increases

66 Pages Posted: 30 Oct 2012 Last revised: 29 Jul 2014

See all articles by Carl Hsin-han Shen

Carl Hsin-han Shen

Macquarie University, Macquarie Business School

Hao Zhang

Rochester Institute of Technology (RIT) - Saunders College of Business

Date Written: October 30, 2012

Abstract

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases where firms increase their R&D investments by an economically significant amount over the period from 1995 to 2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high vega may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.

Keywords: Executive Compensation, Managerial Incentives, Risk Taking, R&D, Innovation, Investment Efficiency, Overinvestment, Firm Performance, Executive Stock Option, Vega

JEL Classification: G3, G30, J33, M12, O32

Suggested Citation

Shen, Carl Hsin-han and Zhang, Hao, CEO Risk Incentives and Firm Performance Following R&D Increases (October 30, 2012). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2163333 or http://dx.doi.org/10.2139/ssrn.2163333

Carl Hsin-han Shen

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Hao Zhang (Contact Author)

Rochester Institute of Technology (RIT) - Saunders College of Business ( email )

105 Lomb Memorial Dr.
Rochester, NY 14623
United States

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