Equity-Based Incentives, Risk Aversion, and Merger-Related Risk-Taking Behavior

We find that post-merger equity risk is negatively related to the sensitivity of CEO wealth to stock return volatility (vega), but is concentrated in CEOs with high proportions of options and options that are more in-the-money. The probability of industrial diversification also increases in vega. Additional tests show that the decline in post-merger equity risk results in a significant decrease in shareholder wealth. This decrease is concentrated among firms with CEOs having the highest delta and the highest delta and vega. Our results suggest that the increased convexity provided by option-based compensation does not necessarily increase risk-taking behavior by CEOs.