Idiosyncratic risk, risk-taking incentives and the relation between managerial ownership and firm value
Alexandros Kostakis and
European Journal of Operational Research, 2020, vol. 283, issue 2, 748-766
In addition to its well-documented alignment effect, managerial ownership can also have value-destroying effects by shifting risk to managers and encouraging risk-substitution; that is, managers with relatively unhedged 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. We identify a plausible channel for these effects by showing that firms exposed to risk-substitution exhibit more “conservative” investment and financing policies. We also show that the risk-substitution problem is partially mitigated by the inclusion of stock options in managerial compensation packages. Finally, our findings suggest that semi-parametric methods may prove useful for future studies aiming at capturing nonlinear features in the data.
Keywords: Finance; Idiosyncratic risk; Risk-substitution; Managerial ownership; Semi-parametric estimation (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:283:y:2020:i:2:p:748-766
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