CEO Risk-Taking Incentives and the Cost of Equity Capital

Yangyang Chen, Cameron Truong and Madhu Veeraraghavan

Journal of Business Finance & Accounting, 2015, vol. 42, issue 7-8, 915-946

Abstract: In this paper, we show that the sensitivities of an executive's wealth to changes in stock prices (deltas) decrease the implied cost of equity capital while the sensitivities of an executive's wealth to changes in stock volatility (vegas) increase the implied cost of equity capital. Our findings demonstrate that shareholders understand the risks of firms’ future projects as embedded in executive compensation and price these risks into the cost of equity capital accordingly. The findings have strong implications for optimal executive compensation contract design, project evaluation and cost of capital estimation.

Date: 2015
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