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Managerial Risk-Taking Incentive and Firm Innovation: Evidence from FAS 123R

  • Connie X. Mao and Chi Zhang

Abstract

We investigate how chief executive officers’ (CEOs) risk incentive (VEGA) affects firm innovation. To establish causality, we exploit compensation changes instigated by the FAS 123R accounting regulation in 2005 that mandated stock option expensing at fair values. Our identification tests indicate a positive and causal effect of CEOs’ VEGA on innovation activities. Furthermore, dampened managerial risk-taking incentive after the implementation of FAS 123R leads to a significant reduction in innovation related to firms’ core business and explorative inventions. It implies that managers diversify their innovation portfolios and decrease explorative inventions to curtail business risk when their risk-taking incentive is reduced.

Copyright

Corresponding author

* Mao (corresponding author), cmao@temple.edu, Temple University Fox School of Business and Management; Zhang, Chi_Zhang1@uml.edu, University of Massachusetts Lowell Manning School of Business.

Footnotes

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1

We thank an anonymous referee, Mark Chen, Paul Malatesta (the editor), Erik Wang, and seminar participants at Temple University, the 2016 Midwest Finance Association Annual Meeting, and the 2016 Financial Management Association Annual Meeting for their helpful comments and discussions. Mao also acknowledges the Summer Research Award support from Temple University. All errors are solely ours.

Footnotes

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