Stock option pay versus restricted stock: A comparative analysis of their impact on managerial risk-taking and performance extremeness

This study investigates how two stock-based incentives affect the risk-taking behavior of CEOs. We compare stock options and restricted stock in terms of their impact on the magnitude of investments and performance extremeness. We test our hypotheses using data for 23 years starting from 1993 for a large sample of S&P 1500 firms. Our results indicate that both stock option and restricted stock pay increase the magnitude of investments undertaken by CEOs, but that stock options have a much stronger effect. Also, stock option pay increases the likelihood of both big gains and big losses, but restricted stock reduces the likelihood of big losses. Finally, we find that as CEO tenure increases, the effects of stock-based compensation tend to diminish. Therefore, stock-based incentives appear to be a useful solution to the agency problem for short-tenured CEOs, but much less so for long-tenured CEOs.