Business Exposed112
Hambrick from Penn State University. They examined 950
American CEOs, their stock options and their risk-taking
behavior. They found that CEOs with many stock options made
much bigger bets: for instance, they would do more and larger
acquisitions, bigger capital investments, and higher R&D expend-
itures. That is, where CEOs with few stock options would prefer
to invest $50 million in a particular project, they would plunge
in $100 million.
However, in addition, they would bet (that rather substantial
amount of) money on things that had much higher variability.
That is, if there was a project that could make them win or lose
20 percent of the sum invested and another project that could
make them win or lose 50 percent, they would pick the latter; big
bets with lots of variance.
Yet, I guess those could still be regarded “good risks”. Gerry and
Don, however, also found something else: option-loaded CEOs
delivered signicantly more big losses than big gains! They
would more often lose than win the big bets. Surely that is not
something anyone would want.
And why is that? Well, through these stock options, you have
created individuals at the helm of your rm who only care about
the up-side, but can’t be bothered with the size of the down-side;
whether they lose $10 million or $100 million, their stock
options are worthless anyway.
And it gets worse. Professor Xiaomeng Zhang and colleagues,
from the American University in Washington, D.C., examined
the relationship between stock options and earnings manipu-
lations: plain illegal behavior. They investigated 365 earnings
manipulation cases and showed that CEOs with many “out
of the money” options were more likely to misrepresent their
company’s nancial results (and get caught doing it!).
And I guess that’s not something even the biggest risk-loving
shareholder would applaud. Hence, even if as a board member or
shareholder you’d want to stimulate your CEO to take more risks
– and I guess that is a big if – I am not so sure that stock options