Executive stock options and systemic risk

Christopher Armstrong, Allison Nicoletti and Frank S. Zhou

Journal of Financial Economics, 2022, vol. 146, issue 1, 256-276

Abstract: Employing a novel control function regression method that accounts for the endogenous matching of banks and executives, we find that equity portfolio vega, the sensitivity of executives’ equity portfolio value to their firms’ stock return volatility, leads to systemic risk that manifests during subsequent economic contractions but not expansions. We further find that vega encourages systemically risky policies, including maintaining lower common equity Tier 1 capital ratios, relying on more run-prone debt financing, and making more procyclical investments. Collectively, our evidence suggests that executives’ incentive-compensation contracts promote systemic risk-taking through banks’ lending, investing, and financing practices.

Keywords: Executive compensation; Equity incentives; Systemic risk; Business cycles (search for similar items in EconPapers)
JEL-codes: E32 G21 G32 J33 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:146:y:2022:i:1:p:256-276

DOI: 10.1016/j.jfineco.2021.09.010

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