CEO compensation and risk taking: S&P 1500 firms

CEOs in United States firms have experienced significant compensation gains since the late 1970s. A key component of these compensation packages are stock options, which now represent a larger share of total compensation. This reliance on stock options may encourage CEOs to focus on short-term performance, potentially incentivizing excessive risk taking to boost the firm’s stock price. We utilize a sample of publicly traded firms in order to comment on the extent to which compensation and risk taking are related, and in particular, if compensation is associated with risky corporate behaviors. We use data from S&P 1500 firms and their Chief Executive Officers (CEOs) for the period of 2006–2022, sourced from Compustat and Execucomp databases. In this paper, we proxy firm-level risk-taking behavior through Altman’s Z-score and stock volatility. To address the likely endogeneity of compensation, we employ a Two-Stage Least Squares approach; we instrument CEO tenure and firm size and include two sets of policy and asset pricing controls. Ultimately, we find a strong positive relationship between CEOs’ stock and options awards and risk taking as represented by Altman’s Z-score and stock volatility. By contrast, CEO’s total compensation is reversely correlated with Altman’s Z-score and stock volatility.