CEO Risk-Taking Incentives and the Cost of Equity Capital
Author(s)
Chen, Yangyang
Truong, Cameron
Veeraraghavan, Madhu
Griffith University Author(s)
Year published
2015
Metadata
Show full item recordAbstract
In this paper, we show that the sensitivities of an executive's wealth to changes in stock prices (deltas) decrease the implied cost of equity capital while the sensitivities of an executive's wealth to changes in stock volatility (vegas) increase the implied cost of equity capital. Our findings demonstrate that shareholders understand the risks of firms’ future projects as embedded in executive compensation and price these risks into the cost of equity capital accordingly. The findings have strong implications for optimal executive compensation contract design, project evaluation and cost of capital estimation.In this paper, we show that the sensitivities of an executive's wealth to changes in stock prices (deltas) decrease the implied cost of equity capital while the sensitivities of an executive's wealth to changes in stock volatility (vegas) increase the implied cost of equity capital. Our findings demonstrate that shareholders understand the risks of firms’ future projects as embedded in executive compensation and price these risks into the cost of equity capital accordingly. The findings have strong implications for optimal executive compensation contract design, project evaluation and cost of capital estimation.
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Journal Title
Journal Of Business Finance And Accounting
Volume
42
Issue
7-8
Subject
Accounting, Auditing and Accountability not elsewhere classified
Accounting, Auditing and Accountability
Banking, Finance and Investment