An Empirical Investigation on CEOs' Option Incentives and Firms’ Risky Financing Policy : Evidence from Australian Public Companies

In order to align executives' interests with shareholders' interests, board of directors has rewarded executives with more option-based payments in the past decades. However, as volatility of share return increases, CEOs are more risk averse because their human capital and wealth are undiversified. Consequently, CEOs may pass up risky but value-enhancing corporate policy decisions. High pay-equity risk sensitivity (vega) CEOs are hypothesised to have more incentive to adopt more risky corporate policy, given that the volatility of the underlying share increases option value in Black-Scholes option pricing model.This study investigates the effect of vega on firm's book leverage and vega determinants based on a panel data of 137 Australian firms from 2003 to 2012, a period in which the federal government implemented a series of executive pay reforms to tie the pay more closely to performance. The results show that vega has a significant and positive effect on firm's leverage. In addition, the results demonstrate that there is a negative and statistical significant association between vega and CEOs' risk-aversion such as the option moneyness and cash compensation. This study also provides evidence that firm size has a significantly positive effect on firms' debt financing. Furthermore, in-the-money options and executive cash compensation have significant and negative impact on vega