Does stock option compensation encourage managerial risk taking

Decision makers who have nothing to lose, but a lot to gain, may exhibit an unhealthy preference for riskier projects. Evidence from several studies shows that stock option rewards help overcome managers’natural risk aversion, by providing a floor to avoid losses while allowing them to benefit from upside gains. Rewarding managers for real performance is strongly recommended in Corporate Governance Codes (including Tabaksblat in the Netherlands). This article shows that compared to traditional stock options, performance-vested stock options may further increase managerial preference for risky projects and encourage risk-seeking behavior; which clearly is not always desirable.

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