Incentives drive managers to 'engage in other risky practices'
Incentivising chief executive officers (CEOs) with stock options can increase the likelihood of workplace misconduct, according to new research.
The study, published in The Accounting Review, found that there is a "positive relation" between CEO vega and workplace misconduct.
CEO vega refers to a metric that measures the sensitivity of a CEO's wealth to changes in the volatility of their company's stock price.
"The observed relation between CEO vega and workplace violations is economically significant," the study said.
A one standard deviation increase in CEO vega is related to an increase of 6.7% in the number of violations and an increase of 5.5% in the value of penalties, according to the study.
"Stock options incentives can influence investment and financial decision-making, encouraging CEOs to pursue riskier projects and riskier financing strategies," said Dr. Monika Tarsalewska, a Senior Lecturer and Deputy Director of the Exeter Sustainable Finance Centre at the University of Exeter Business School, in a statement.
"However, they can also drive managers to engage in other risky practices, such as accounting manipulation and fraud."
According to the study, CEOs may take riskier strategic workplace decisions that directly affect workplace misconduct by cutting safety-related expenditures.
They may also indirectly affect workplace misconduct by imposing a heavy workload on employees.
"Specifically, the relationship between CEO vega and workplace violations is a function of reductions in safety-related spending and increased workloads," the study said.
The study further underscored the connection of CEO vega and workplace misconduct by looking at the impact of the Statement of Financial Accounting Standard 123R (SFAS 123R).
SFAS 123R significantly reduced the use of stock options in executive compensation contracts.
"Given that it is unlikely that the implementation of SFAS 123R had an influence on the number and severity of workplace violations other than through its effect on CEO vega, we believe that these results support our conjecture that CEO vega influences workplace misconduct," the study said.
The findings highlight the potential danger of putting CEOs under pressure to innovate through financial incentives, which has been long regarded as a measure to improve performance.
Findings from the Melbourne Business School revealed that as CEO option wealth increased, there was also a positive effect on productivity.
"The more the stock options were worth, the more the CEO sought to increase productivity as a risk-free way to maintain, and increase share price," said Associate Professor of Finance Leon Zolotoy in a statement.
"We were able to show that option wealth isn't all evil – there is another effect here."
But a 2023 study published by researchers from Carnegie Mellon University and Seoul National University has also underscored that financial incentives may not be as effective as initially thought.
The study found that stock options for CEOs did not influence the return on assets or any market-related metrics in the following year.
While CEO bonuses had a modest predictive impact on return on assets, they also did not significantly affect other performance indicators like stock returns or market-to-book value, according to the study.
"Despite the widespread use of financial incentives for CEOs as drivers of firms' performance, our findings suggest it may be problematic to justify current CEO compensation arrangements based on anticipated market results," said Byeong Jo Kim, associate professor of public management at Seoul National University's School of Public Administration and one of the co-authors of the study.
