CEO risk incentives and firm performance following R&D increases

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases in which firms increase their R&D investments by an economically significant amount over the period of 1995-2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high-vega compensation portfolios may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.

► We analyze how CEO risk incentives affect R&D investment efficiency. ► Firms with higher compensation vega are more likely to increase R&D investments. ► High-vega firms underperform low-vega firms in stock returns after R&D increases. ► High-vega firms also underperform in operating performance. ► High-vega compensation may induce manager to overinvest in inefficient R&D project.