The convex pay-off structure of executive stock options (ESO) incentivizes CEOs to increase their firm stock-return volatility, thereby increasing their wealth in option portfolio. In this paper, I address two research questions. I first test if this managerial incentive induces executives to take on more risky projects in R&D that increases stock- return volatility, hence, boosting their personal wealth. I derive vega to measure managerial incentive, and vega is a dollar change in ESO for a 0.01 change in stock- return volatility. I find that there is a positive and statistically significant relationship between vega and R&D investment, which suggests that managers whose wealth is closely tied to stock options are more incentivized to invest in risky R&D projects to increase their wealth and stock-return volatility. This result is statistically significant and robust after adjusting for inflation and controlling for firm and industry-fixed effects. With this finding, I proceed to test if managerial risk-taking incentive for R&D investments translate to future earnings. Lev and Sougiannis (1996) establish that future earnings is a function of both tangible and intangible assets, and R&D increases with firm’s subsequent earnings. Since R&D spending changes with managerial incentive, I test if the interactive variable of vega and R&D has a positive effect on firm’s future earnings. I find that managerial incentive for undertaking R&D investments has a positive and statistically significant association with future earnings under industry-fixed effects specifications. When controlling for firm-fixed effects, the result yielded similar results to that of industry-fixed effects, but with less statistical significance. Lastly, for robustness check, I run the regression with a balanced panel data of tenured-CEOs, who stay with the firm for five years. I find that the result is positive and statistically significant for industry-fixed effects. However, for firm-fixed effects, I only find statistical significance at year t+k (k=3). This suggests that the realization of R&D investment to future earnings is not prevalent throughout all years when R&D decisions are made by incentivized, long-standing CEOs.
| Identifer | oai:union.ndltd.org:CLAREMONT/oai:scholarship.claremont.edu:cmc_theses-3245 |
| Date | 01 January 2019 |
| Creators | Cho, Ha Yun |
| Publisher | Scholarship @ Claremont |
| Source Sets | Claremont Colleges |
| Detected Language | English |
| Type | text |
| Format | application/pdf |
| Source | CMC Senior Theses |
| Rights | © 2019 HaYun Cho, default |
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