Submitted by: Submitted by sonik1981
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Category: Business and Industry
Date Submitted: 05/21/2016 10:30 AM
HOW CEO WEALTH AFFECTS THE RISKINESS OF A FIRM
OLD DOMINION UNIVERSITY
FIN 863
FINAL PROJECT
BY
SONIK MANDAL
CHARLIE SWARTZ
INTRODUCTION
Agency theory states that the goals of the owners and the managers of a firm diverge in a way that the managers take less risk since their ownership of the company is much less compared to the owners of the firm who have a much bigger stake in the company. Thus managers being risk averse, they forego profitable ventures if they anticipate them to be risky (Guay, 1999, Jensen & Meckling, 1976). Making the salary structure more convex by introducing more option-based compensation and stock awards is one-way owners try to align the goals of the managers with the owners. However, managerial wealth attached to the firm is only a fraction of their total personal wealth in the portfolio. Other components of manager’s total wealth could be stocks owned in other companies, real estate portfolio, and other debt related securities. A lot of research has been done in the past explaining how managerial compensation structure (options, stock awards etc.) affect his risk taking abilities (Knopf et al. 2002, Rogers, 2002, etc.). Nevertheless, not much research has been done showing how a manager’s outside wealth affects his risk taking in the firm. As far as we know, the only paper that has looked at this relationship is by Elsila et al. 2013 but that paper only looked at the Swedish listed firms. They found that higher the proportion of the CEOs wealth to the firm, more risk averse the manager would be. Similar to them, we would be using the “wealth ratio” variable, which is defined as the proportion of the manager’s total personal wealth invested in the company. It has been shown in the previous literature that higher delta corresponds to more risk taking and higher Vega of option portfolio of manager corresponds to less risk taking (Knopf et al. 2002, Rogers,...