The sensitivity of CEO wealth to equity risk: an analysis of the magnitudeand determinants

To control risk-related incentive problems, equity holders are expected to manage both the convexity and slope of the relation between firm performanc e and managers' wealth. I find stock options, but not common stockholdings, significantly increase the sensitivity of CEOs' wealth to equity risk. Cro ss-sectionally, this sensitivity is positively related to firms' investment opportunities. This result is consistent with managers receiving incentive s to invest in risky projects when the potential loss from underinvestment in valuable risk-increasing projects is greatest. Firms' stock-return volat ility is positively related to the convexity provided to managers, suggesti ng convex incentive schemes influence investing and financing decisions. (C ) 1999 Elsevier Science S.A. All rights reserved.