CEO risk incentives and corporate cash holdings
Tong, Zhenxu
Date: 1 December 2010
Journal
Journal of Business Finance and Accounting
Publisher
Wiley-Blackwell
Publisher DOI
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Abstract
We empirically test the risk-reduction hypothesis of the agency theory in the context of
corporate cash holdings. Since corporate cash holdings can be viewed as risk-free investments,
the risk-reduction hypothesis predicts that a risk-averse and self-interested CEO allocates
more firm assets to corporate cash holdings to reduce firm ...
We empirically test the risk-reduction hypothesis of the agency theory in the context of
corporate cash holdings. Since corporate cash holdings can be viewed as risk-free investments,
the risk-reduction hypothesis predicts that a risk-averse and self-interested CEO allocates
more firm assets to corporate cash holdings to reduce firm risk at the expense of giving up
some positive NPV but risky projects, which is not beneficial to shareholders. We use the
sensitivity of the value of a CEO’s stock options to stock return volatility (Executive Stock
Options risk incentives) to study the relation between a CEO’s risk incentives and corporate
cash holdings. We find that firms with lower ESO risk incentives have more corporate cash
holdings. We find that more corporate cash holdings reduce firm risk, and that corporate cash
holdings have a negative marginal impact on firm value due to the risk-related agency
problem. These findings are consistent with the risk-reduction hypothesis of the agency
theory in the context of corporate cash holdings.
Finance and Accounting
Faculty of Environment, Science and Economy
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