Executive Stock Options and Corporate Restructurings: The Differential Risk-Taking Incentives of Vega and Delta

Abstract

Using an extensive dataset featuring the corporate restructuring transactions, including acquisitions and divestitures, completed by 2,707 firms from 1992 through 2006 and the terms of the executive stock options (ESOs) of their CEOs, the effects of the ESO Black-Scholes vega and delta on the probabilities of completing transactions expected to increase total, systematic, and idiosyncratic firm-risk are determined. Vega is found to make CEOs more likely to complete transactions expected to increase total firm-risk and more likely to complete transactions expected to increase systematic risk than those expected to increase idiosyncratic risk, providing evidence for the recent theory that ESO vega incentivizes managers to increase systematic instead of idiosyncratic firm-risk because systematic risk can be more easily hedged. In contrast, delta is found to make CEOs more likely to complete transactions expected to increase idiosyncratic risk than those expected to increase systematic risk. Collectively, these results imply the structure of ESOs affects whether managers forgo projects increasing one component of total firm-risk (systematic or idiosyncratic) for those that increase the other component of total firm-risk, which in turn determines whether ESOs provide risk-taking incentives that align with the interests of shareholders and promote maximization of shareholder value.