Large Owner Expropriation Threat and Stock Option Pay's Effect on Firm Risk-Taking Behaviors in Weak Institutions

Abstract

Research Question/Issue

This study investigates the impact of managerial stock option pay on firm risk-taking behaviors in a weak institutional context, a critical question that has been overlooked by the literature. Specifically, we build on the comparative corporate governance perspective that emphasizes the implications of large shareholders' expropriation threat in weak institutions to develop predictions about their impact on the stock option's incentive alignment effect. We further explore the boundary conditions of such a relationship.

Research Findings/Insights

Based on a sample of Chinese listed firms between 2006 and 2016, we find that a high level of large shareholders' expropriation threat weakens the effect of stock option value on firm risk-taking. We also find that such an adverse impact of large shareholders on the effect of stock option value is mitigated by the institutional factors that strengthen the protection of the interests of minority shareholders.

Theoretical Implications

Our results underscore the importance of integrating the potential expropriation risk due to large shareholders and the institutional contexts into understanding the effectiveness of incentive-alignment governance practices such as stock option pay in the context with weak institutions (e.g., China).

Practitioner/Policy Implications

Our findings offer insights for policy makers to better design the regulatory and institutional frameworks to increase the effectiveness of corporate governance practices. It also shows that firms in the context of weak institutions need to be more cognizant when adopting certain corporate governance practices (i.e., stock option pay for the incentive-alignment purpose).