How Does Managerial Equity Compensation Predict Risk Management? A longitudinal Case-study in the U.S Oil and Gas Industry

Abstract

Aim and Objectives The aim of this thesis was to help explain how managerial equity compensation predicts corporate risk management through the effect it has on managerial incentives. The exact research objectives changed during the research process. Originally, the research objective was to provide further empirical evidence in support of the common theory that a linear relationship exists between managerial equity compensation and risk management. Conflicting research results led the author to rethink the nature of the relationship and prompted a change of objectives. Inspired by opposing arguments and ideas in the extant literature, this thesis presents a revised view on the relationship between equity compensation and risk management. Methodology This thesis used the U.S Oil and Gas Industry as a case study since these companies all share a common exposure to a volatile, globally traded commodity, namely oil. Linear regression analysis was used to test for a linear relationship between managerial equity compensation and risk management. Analysis of variance (ANOVA) was used to test for a non-linear relationship between different compositions of equity holdings (stocks and options) and risk management. The sample included all companies with SIC code 1311 that also had consistent compensation data available in Execucomp between 1993 and 2014. The degree of risk management for each company was proxied for using the correlation coefficients between the stock price and the oil price for the individual firms.Findings The key findings of this thesis were that in contrast with the common theory, no evidence of a linear relationship between managerial equity compensation and corporate risk management was found. Additionally, further analysis using analysis of variance supports the idea that a non-linear relationship exists and lends support to the revised view presented in this thesis. Contrary to popular belief, this suggests options may decrease a manager’s appetite for risk in the presence of wealth or when deep in-the-Money Conclusion This thesis contributes to the discussion on how managerial compensation affects management incentives towards risk management in two ways. First, it provides empirical evidence in favor of the opposing arguments that a non-linear relationship between equity compensation and risk management exists. Second, building on the different opposing arguments and ideas in the extant literature of a non-linear relationship, this thesis proposes a revised view on how to better understand the relationship between equity compensation and risk management incentives. The research in this thesis provides mixed support for this proposition. Implications If the revised view presented in this thesis is correct, businesses can potentially design compensation contracts that better align managerial incentives with the interest of the shareholders.