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  • CEO Risk-Taking Incentives and the Cost of Equity Capital

    Author(s)
    Chen, Yangyang
    Truong, Cameron
    Veeraraghavan, Madhu
    Griffith University Author(s)
    Veeraraghavan, Madhu
    Year published
    2015
    Metadata
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    Abstract
    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
    DOI
    https://doi.org/10.1111/jbfa.12126
    Subject
    Accounting, Auditing and Accountability not elsewhere classified
    Accounting, Auditing and Accountability
    Banking, Finance and Investment
    Publication URI
    http://hdl.handle.net/10072/172407
    Collection
    • Journal articles

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