An Empirical Analysis of the Causal Relationship Between Equity Incentives and Idiosyncratic Volatility in Chinese A-Share Listed Companies

In recent years, the relationship between equity incentives (EI) and idiosyncratic volatility (IV) has become an increasingly important topic in corporate finance research. By creating a measure of EI using the entropy approach and researching the link between EI and IV in Chinese A-share listed corporations from 2016 to 2019, this study adds to the body of literature. The regression analysis results show that EI are positively correlated with IV, suggesting that EI may increase company-specific risk. This finding adds to the “IV puzzle” by providing evidence of a potential driver of non-systematic risk. The use of the entropy method to construct a measure of EI is another innovation of this study. This method provides a comprehensive measure of EI that considers both the size and structure of EI, which is more accurate than traditional measures. The empirical analysis also controls for other potential factors that may influence IV, such as firm size, leverage, and profitability. Overall, this study provides empirical evidence of the relationship between EI and IV, which has important implications for corporate governance and risk management. The results suggest that managers should carefully consider the potential risks associated with EI when designing compensation schemes, and investors should pay attention to the potential impact of EI on company-specific risk.