Idiosyncratic risk, risk-taking incentives and the relation between managerial ownership and firm value

Florakis, Chris ORCID: 0000-0002-1290-4168, Kanas, Angelos, Kostakis, Alexandros ORCID: 0000-0002-2358-6484 and Sainani, Sushil ORCID: 0000-0002-1879-7869 (2020) Idiosyncratic risk, risk-taking incentives and the relation between managerial ownership and firm value. European Journal of Operational Research, 283 (2). pp. 748-766.

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Abstract

In addition to its well-documented alignment effect, managerial ownership can also have value-destroying effects by shifting risk to managers and encouraging risk-substitution; that is, managers with relatively unhedged personal portfolios tend to pass up profitable projects with high idiosyncratic (firm-specific) risk in favor of less-profitable projects that have greater aggregate (market) risk. Using parametric and semi-parametric estimation methods, we examine how managerial ownership influences firm value in light of the trade-off between the alignment and the risk-substitution effects. We find that risk-substitution offsets the alignment effect of managerial ownership in firms that are exposed to severe risk-substitution problems, leading to a weak (or non-existent) association between managerial ownership and firm value. We identify a plausible channel for these effects by showing that firms exposed to risk-substitution exhibit more “conservative” investment and financing policies. We also show that the risk-substitution problem is partially mitigated by the inclusion of stock options in managerial compensation packages. Finally, our findings suggest that semi-parametric methods may prove useful for future studies aiming at capturing nonlinear features in the data.

Item Type:	Article
Additional Information:	Source info: European Journal of Operational Research, Forthcoming
Uncontrolled Keywords:	Finance, Idiosyncratic risk, Risk-substitution, Managerial ownership, Semi-parametric estimation
Depositing User:	Symplectic Admin
Date Deposited:	02 Jan 2020 15:42
Last Modified:	19 Jan 2023 00:11
DOI:	10.1016/j.ejor.2019.11.027
Related URLs:	Author Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3068861