Do stock options in executive pay increase risk taking behavior?

Transcription

1 Do stock options in executive pay increase risk taking behavior? Bachelor thesis Faculty of Economics and Business Administration R. Alferink s Supervisor: V.L. van Kervel May, 2011

2 Chapter 1: Intro Bonuses on Wall Street are back. After the credit crunch of 2007, the enormous executive compensation of financial firms has been much criticized. Recently the Dutch secretary of finance de Jager stated in Het financieele dagblad 1 that not only financial institutions with direct aid, but also banks issuing bonds guaranteed by the State, may now no longer pay bonuses. Some companies are trying to regain the confidence of the people by changing its bonus policy. Jan Hommen, the CEO of ING said he will forgo his 1,25 million euro bonus after a public outcry. Nevertheless, according to the Wall Street Journal, the pay of Wall Street executives is expected to hit a record of $144 billion in That is an increase of 4% in The revenue of these firms however are rising one percent less than the compensation. The pressure on executives to temper the bonuses doesn t seem to change the bonus culture. Compensation policy can play a critical role in an organization s success. It influences executives how to behave and it also helps determine what kind of executives an organization attracts. CEO s do not usually own the firm they control, and this can create different interests for the CEO and the shareholder. One of the first studies done in this area was done by Jensen and Murphy (1990). They studied the conflict of interest between shareholders of a publicly owned corporation and the CEO. The title of their research is: It s Not How Much You Pay, But How. They argue that the focus of the critics is wrong. Many critics fixate too much on the amount of the compensation, rather than the structure. The relationship between the performance of the firm and the compensation of the CEO often is too small. This way, CEO s are not encouraged enough to maximize firm value. Shareholders want the CEO s to maximize firm value. However, they cannot perfectly observe every activity of a CEO and they do not know everything about the possible investment opportunities. There exists information-asymmetry. It s a classic example of the principal-agent problem. Executive compensation is a tool used by shareholders to reduce this problem. 1

3 The remuneration of CEO s consists of a fixed and a variable part. An extreme example is the remuneration of the CEO of Citigroup. Vikram S. Pandit received a (symbolic) fixed annual salary of only 1$ for But his variable bonus was worth $23,3 million, of which as much as $16,5 million in stock options. The variable part is used to try to align the incentives of the CEO and the shareholders. Stock options are a popular way to decrease agency problems. A CEO has a bigger incentive to maximize firm value when his pay constitutes a mix of fixed and variable compensation (Chourou et al, 2008) If a manager is rewarded with a fixed salary only, his wealth doesn t increase when the performance of the firm increases. But when the manager is also rewarded with stock options, his personal wealth will increase if the firm performs better. This is because an increase in stock price will also increase the value of the options he is rewarded. A problem with stock options is that it doesn t always reward the CEO perfectly for their performance. A rise or fall of stock prices cannot be fully attributed to a CEO. Executives like to think that they are responsible for a rise in stock prices of the firm, but the factor luck also plays a large role. As a consequence, executives are not only paid for their performance, but also for luck. Bertrand and Mullainathan (2000) found evidence that can be indeed the case. The industry in which the CEO operates will highly influence the way they are compensated. A recent survey of Forbes magazine found that 86 percent of the S&P500 companies reward the executives on the basis of how other companies compensate their CEO s in the same industry sector. 3 Stock options are often criticized because they can create short-term incentives for the CEO. This is not always beneficial for the long term of the firm. Options create a (large) upside for the CEO when the firm performs well, but there isn t an equivalent downside. When the firm performs poorly, the manager will not exercise the options because the options are worth zero. His own wealth is not so much as risk as is the wealth of the investor. This risk asymmetry between a shareholder and an investor can boost incautious risk taking of the CEO on the short term. If it is the case that managers take more imprudent risks when they are rewarded with stock options, it is expected that the volatility will rise. This paper investigates whether CEO s indeed take more risks when they are rewarded with stock options. The research question is. 2 Eric Dash As Citi Revives, Pandit Wins Big Pay Package, May 18, 2011, (nytimes.com) 3 Emily Lambert, The Right Way To Pay May 11, 2009, (forbes.com)

4 Is there a positive relation between the use stock options and the volatility of the firm? The main empirical finding is that this hypothesis is not supported by the data. There is no evidence found that stock options will increase the volatility of the firm. The relation between the number of stock options owned, and the value of the stock options owned turned out to be not significant. This doesn t mean that a stock option doesn t influence the volatility at all. It is possible and logical as stated in the theory that the options do influence choices the managers make. Shareholders should be cautions to use stock options as the only way to align the CEO s incentives. They do not only reward the CEO for his performance, but can also reward him for luck. Also, other factors play a role in the decisions the executive makes than money. Chapter 2: Literature 2.1 Agency theory The separation of ownership and control is the quintessential agency problem (Murphy, 1998). Adam smith was one of the first to describe the problem in his well known book The Wealth of Nations. It cannot be expected from managers to watch over other people s money with the same anxious vigilance with which they would watch over their own money. In essence, the agency problem states that the separation creates different incentives for the shareholder and the manager. The shareholder owns the company, but the manager is taking the decisions. Shareholders want the CEO s to maximize firm value. Managers are assumed to work in the best interest of the shareholders, but because managers don t own the company, they can behave self-interested and maximize their own utility. To decrease the agency conflicts, Jensen and Mecklink (1976) state that the compensation of managers should be linked with the performance of the firm. This is why the salary of executives consists of a mix of fixed and variable rewards. The variable rewards are used as a performance based compensation. According to the agency theory, the executive compensation should be optimally designed in a way that the manager has incentives to maximize shareholder value. One way to achieve this is through the use of stock options.

5 2.2 CEO Rewards According Firth et al. (1999), companies need to structure their pay to attract, retain, motivate and award senior executives. Companies try to find an optimal mix between fixed and variable rewards to align the incentives. Abowd and Kaplan 1999 defined executive compensation as mixture of four components. 1. Salary. 2. Annual bonus 3. Benefits 4. Long term compensation. Salary is the cash compensation, this is determined at the beginning of an annual pay cycle. Annual bonus is also cash compensation, but the bonus is determined at the end of an annual pay cycle and is based on only one-year s worth of performance information. Benefits include costs like insurance, health care and retirement plan. The long-term pay is the annualized present value of cash(equivalent) compensation that is based on the managers performance more than one year. Long term compensation includes stock options. The focus of this study is on this part of the compensation, the stock options. Black and Scholes (1973) studied performance pay of executives before. They discovered a model to calculate the price of an option. Their work led to a rise in the use of options, and it is now widely used to calculate the price of an option. 2.3 The stock option The use of stock options in CEO compensation has risen sharply over the past 20 years in proportion to the total compensation. In the US, CEO s receive a larger part of their compensation in the form of stock options than any other country. A stock option is a contract that gives the manager the right, but not the obligation, to buy or sell the stock at a fixed price (strike price) for a pre-specified term. They are non-tradable, and are typically forfeited if the executive leaves the firm before vesting (Murphy, 1998).

6 At first sight it seems that the incentives are aligned. A manager who owns stock options has an incentive to maximize the value of the firm. When the stock of the firm rises, both the shareholder and the manager will benefit. It provides the most direct link between the wealth of a CEO and the shareholder (Murphy, 1998). Both the shareholder and the manager seem better off. It is questioned however whether the stock option compensation actually aligns the different incentives as described by the agency problem. The pay-to-performance relationship seems to be in accord with the most basic predictions of agency theory (Aggarwal and Samwick, 1999). The problem lies in the fact that the manager is not obliged to exercise at the expiration date. As a consequence, when the stock price falls below the exercise price, the manager will not bear the loss. The manager will profit from a rise in the stock, but will not lose when the stock falls. This imposes a strong incentive for the manager to engage in riskier investments. According to Carpenter (2000), stock options influence incentives in two ways. The first is that the manager is indifferent whether the stock price is just a little below the exercise price or whether the stock price is far below the exercise price. The value is always zero, no matter how low the stock prices are. The second effect is that a rise of the stock price above the exercise price is directly related with the rewards of the manager. This increases the incentive to increase stock value, but also to take more risk. 2.4 Measuring effects of compensation incentives. Core and Guay (2002) measured the incentives effect of stock options by using the modified version of the Black-Scholes option valuation model by Merton (1973) to account for dividends. The incentive of a CEO to increase stock price was measured as Delta: change in CEO wealth (value of the option) towards a 1% change in the stock price. The incentive of a CEO to increase risk was measured as Vega: change in CEO wealth (value of the option) towards a 1% change in volatility.

7 Figure 1 shows the relevance of these estimates. The price-to-strike is calculated as the stock price divided by the strike ratio. The price-to-strike ratio measures the extent to which the option is worth exercising, or in the money. It is clear that the delta and the vega depends heavily on the price-strike ratio. When the executive option is deep in the money (high price-to-strike ratio), it is very insensitive to changes in the volatility and very sensitive to the stock price. Lewellen (2003) argues that options can also decrease risk taking behavior when the options of the executive are deep in the money and is a large part of the CEO compensation. In that case the CEO can lose a big part of their rewards if they take too much risk. When the price-to-strike ratio moves further to the left to deep out of the money, the opposite conclusion will hold. Then the option will be more sensitive to volatility. This is in line with the hypothesis that CEO s will increase risk taking when the option is deep out of the money. After heavy losses, the CEO now has more incentive to gamble for resurrection, even if this project has a negative NPV (Chen et al. 1994). As such, additional shareholder value will be destroyed and agency costs increase. Fig.1. The sensitivity of option value to stock price and stock-return volatility as a function of the price to strike ratio, Core and Guay (2003)

8 Coles, Daniel and Naveen (2006) used the same measure and found empirical evidence that the levels of Delta and Vega play an important role in investment policy decisions. They found that a higher vega (more sensitivity of CEO wealth to stock volatility) results in riskier policy choices. This includes a relative increase in investment of research and development, a decrease PPE(property, plant and equipment), less diversification and a higher level of leverage. According to Bhagat and Welch (1995), R&D expenditures are in most cases seen as high risk investments compared to capital expenditures on PPE. If a CEO has an incentive to increase the risk, a way to increase volatility is to increase investments in R&D, and decrease investments in PPE. More diversification will decrease the firm s risk. So a risk seeking executive with a relatively high vega will lower diversification to increase the volatility. This evidence supports the theories that the structure of executive compensation can actually influence the risk-seeking behavior of CEO s. 2.5 Critiques Chance (1997) thinks that stock options are not the best way to align the managers interest with the shareholder. In his view, a forward contract is a better instrument because this way the forward holder has an obligation buy the stock at maturity. As a result the executive would also lose when the stock price falls in contrary to stock options. Chance argues that stock options create wrong incentives because it s like betting without the possibility of losing. CEO s would accept riskier investments with stock options than with forward contracts, because with the stock options they can lose their own money. The more dominant view is that variable pay is used to solve the agency problem. But there is a school of thought who argues that pay is a result of an agency problem. Variable rewards do not reward individual managers perfectly for their performance. In times when the economy is blossoming, the stock prices can rise which can be attributed to the growing market. The rise in share price cannot be fully attributed to the qualities of the managers, but luck plays a large role. Bertrand and Mullainathan (2001) found that CEO pay in fact responds as much to a lucky dollar as to a general dollar. Luck is defined as observable shocks to performance beyond the CEO s

9 control, like changes in oil price. In 2000 they found that CEO s are paid a substantial amount for luck. It can be concluded that variable pay is not the perfect instrument to reward individual CEO s for their performance because of the factor luck, but it can still be used to decrease the agency conflicts. 2.6 Other reasons to use stock options than incentives Financial motives An advantage of the use of stock options to reward CEO arises when companies are facing liquidity constraints. New ventures often struggle with this problem. In situations when cash is scarce, stock options can be a more suitable pay than a simple cash reward. This is because the options do not force the firm to pay cash each year like cash. This way, businesses who do not own enough cash can still operate normally without having to liquidate assets. (Yermack, 1995). In addition, Core and Guay (2001) found that option grants can be used as a substitute for cash remuneration when they face high capital needs and a high cost of accessing capital markets Tax motives. Stock options are being used for tax breaks. The Wall Street Journal reported that Cisco received a tax benefit from the use of stock options of nearly $2.5 billion. At the same time the company reported a profit of $2.67 billion and by deduction of the tax benefit it nearly paid no income taxes at all. The way taxes are levied varies with the type of income. Regular cash salary is treated differently than stock options. Not only the rate but also the timing of tax may vary. Normal cash salary is taxed at the end of every year. This is not the case with stock options. In the United States, the IRS distinguishes between qualified ( Incentive Stock Options ) and non-qualified options. For qualified options, the owner of the stock options pays nothing until exercise. This way the tax can be deferred until exercising the options which creates a tax advantage. Another advantage is the different tax rate than normal income. The gains of exercising the option are classified as a capital gain instead of personal income. The capital gains tax rate is lower than on personal income, which makes it attractive.

10 Most options issued however are non-qualified options. In this case the gains are taxed with the higher personal income rate instead of the capital gain rate. The big advantage however is that the spread between the market price upon exercise and the original price at the date of issue is tax deductible. This can lower the profit of the company, and thereby lowering the taxable income. (Murphy 1999) Retaining and attracting employees. Paying options instead of cash will attract different types of executives. Highly motivated, risk takers and entrepreneurial employees will be more attracted to firms who use stock options remuneration instead of cash because of the high possible payout if they can increase the stock prices. If the cost of attracting a new CEO is large, retaining the best executives can be important for the firm. Rewarding CEO s with stock options is a way to create incentives stay longer with the company. Stock options are often structured in such a manner that the managers can not exercise the options whenever they want. A vesting period is built in, which means that the options can only be exercised at the end of the prespecified period. Even when the manager leaves before the vesting period ends, he is not allowed to exercise the option. The options will be forfeited, and the CEO loses the stock option. In order to exercise the option, the CEO must stay until at least the end of the vesting period. (Oyer& Schaefer, 2005) 2.7 Other factors which influences the CEO: Immaterial income Besides material income, there are other factors which motivates a CEO s to perform well. According to Pennings (1993), Dutch CEO s are also motivated by challenge, pride, freedom, resources and so on. Only linking pay to performance will not always result in desirable CEO performance because this is not the only measure which motivates the executive Large investors In a firm with many small shareholders, the cost of the individual investor to monitor the behavior of the executive may outweigh the possible benefit. This can cause a free-rider problem. As a result it is possible that no small investor will take action, however they would all benefit if they did. Large shareholders, such as institutional investors can play an important role in controlling the behavior of executives (Shleifer and Vishny, 1986). Because they are large, the

11 benefit of control may outweigh the cost. They can exert pressure on the executive compensation structure. Hartzell and Starks (2003) found empirical evidence that institutional investors are active in influencing the executive compensation structure. They conclude that institutional investors serve a monitoring role in mitigating the agency problems between shareholders and managers.

12 Chapter 3: Empirical Part 3.1 Intro The main purpose of this paper is to test whether there is a relation between the number of options owned by the CEO and the volatility of the firm. Another test will be done whether a relation exists between the number of shares owned and the volatility of the firm. Two hypotheses are formulated below. H 1 : The number of shares owned by a CEO is negatively related to the volatility of the firm. H 2 : The number of options owned by the CEO is positively related to the volatility of the firm. Two linear regressions will be used to test the hypotheses. All data used are gathered via the WRDS database. Only data from companies of the S&P500 located in North America are used. This paper will cover all data available from 1992 tot 2009 The dependent variable in the two models will be the volatility. With the first regression, the independent variable is the value of the options owned by the CEO. It is calculated as the total estimated value of the in the money unexercised exercisable options plus the unexercised unexercisable options in dollars. (unexer_val_tot) The dependent variable in the second regegression is the total number of unexercised exercisable options plus the unexercised unexercisable options. (unexer_num_tot) Both the value and the number of options owned from previous year are used to counter for reversed causality. The volatility is measured in percents. Other variables are also included in the model. The model will also test whether the different industry sectors have an influence on the volatility. The SIC code (Standard Industrial Classification) will be used to divide the firms in 9 different industry groups. Nine dummies are included in the model, from Ind1 to Ind9. Ind 1 is taken as the base level.

13 The age of the CEO is included with the variable Age. Several ratio s are included in the model. The assets-to-marketvalue is calculated as the total amount of assets devided by the market value. The cash-to-market and the PPE-to-marketvalue (Property-Plant-Equipment) are calculated in the same way Another ratio that is added to the model is the liabilities/asset ratio. It is calculated as the total amount of liabilities divided by the total amount of asset

14 3.2 The Models Model I: In this model, the dependent variable is the volatility. The independent variables are Unexer_val_tot, Executive s Age, assets-to-market, cashtomarket and PPEtomarket ratio. The industry sector is divided in 9 separate groups using dummies. = + _ _ h Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a a. Predictors: (Constant), Ind9, assetstomarketvalue, Ind1, Ind8, Ind7, lagnumberoptions, Ind2, Ind5, Executive's Age, Ind3, Ind6, cashtomarketvalue, ppetomarketvalue, Ind4 ANOVA b Model Sum of Squares df Mean Square F Sig. 1 Regression a Residual Total a. Predictors: (Constant), Ind9, assetstomarketvalue, Ind1, Ind8, Ind7, lagnumberoptions, Ind2, Ind5, Executive's Age, Ind3, Ind6, cashtomarketvalue, ppetomarketvalue, Ind4 b. Dependent Variable: Volatility - Assumption (%)

15 Coefficients a Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta t Sig. 1 (Constant) Unexer_val_tot Executive's Age assetstomarketvalue cashtomarketvalue PPEtomarketvalue Ind Ind Ind Ind Ind Ind Ind Ind Ind a. Dependent Variable: Volatility - Assumption (%) Y = Unexer_val_tot,206 Age AssetstoMarketvalue + 39,993 CashtoMarketvalue + 2,114 PPEtomarketvalue Ind1.151 Ind Ind Ind Ind Ind Ind7 3,312 Ind8 6,154 Ind9

16 Model II In this model, the dependent variable is the volatility. The independent variables are Unexer_num_tot, Executive s Age, assets-to-market, cashtomarket and PPEtomarket ratio. The industry sector is divided in 9 separate groups using dummies. = + _ _ h Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a a. Predictors: (Constant), Ind9, assetstomarketvalue, Ind1, Ind8, Ind7, Ind2, lagvalueoptions, Ind5, Executive's Age, Ind3, cashtomarketvalue, Ind6, ppetomarketvalue, Ind4 ANOVA b Model Sum of Squares df Mean Square F Sig. 1 Regression a Residual Total a. Predictors: (Constant), Ind9, assetstomarketvalue, Ind1, Ind8, Ind7, Ind2, lagvalueoptions, Ind5, Executive's Age, Ind3, cashtomarketvalue, Ind6, ppetomarketvalue, Ind4 b. Dependent Variable: Volatility - Assumption (%)

17 Coefficients a Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta t Sig. 1 (Constant) Unexer_num_tot E Executive's Age assetstomarketvalue cashtomarketvalue ppetomarketvalue Ind Ind Ind Ind Ind Ind Ind Ind Ind a. Dependent Variable: Volatility - Assumption (%) Y = E 5 Unexer_num_tot,172 Age AssetstoMarketvalue + 40,088 CashtoMarketvalue PPEtomarketvalue Ind1.140 Ind Ind Ind Ind Ind Ind7 3,933 Ind8 6,926 Ind9

18 3.3 Interpretation The values from last year are used for the unexercised owned options. It is assumed in this that the manager has enough power, and is able to change the course of the firm within one year. But it may well be true that this is not the case. Maybe managers are not able to change the riskiness of the firm within one year, but it may take longer than that. This study relies on data of the WRDS database. But not all variables are known in the database, and some are missing. This can cause a problem that the model give a distorted view of reality. Theoretically it can be true that the missing files in reality all show the opposite relation of what is found in this research. Also, the total value and the total number of stock options owned are used in this model as an independent variable. But this doesn t really measure the precise change in wealth of the CEO when the volatility rises. A possible better alternative for further research may be the Vega, which measures how much the wealth of the CEO increases when the volatility rises with 1% can be a better instrument to really measure the incentive effects. Hypothesis 1: : 0 : < 0 For model 1, the value of the total amount of unexercised exercisable and unexercised. Unexercisable options owned by the CEO don t seem to have a relation with volatility. The is with a significance level of According to this model, the value of the options owned last year by the CEO does not influence him to take more risk. The null hypothesis can not be rejected. The significance level of is too high do draw a justified conclusion. For model 2 the is indeed a negative number as expected. The number of unexercised options owned by a CEO was expected to be negatively related to the volatility of the firm. However, the null hypothesis cannot be rejected for two reasons. First, the significance level is too high (0.082) to make an accurate conclusion. Second, the negative value of is very small, -1,613E-5. This value would imply that when Unexer_num_tot increased with one last year, the volatility would decrease with -1,613E-5. Another way to put it is that the volatility of the firm would decrease next year with -0, % when the CEO receives another option. The mean of Unexer_num_tot is , and the standard deviation is An increase with of

19 Unexer_num_tot with one standard deviation would imply a decrease in the volatility of %. Such a small percentage can be neglected since the mean of the volatility is 31.99% and the standard deviation is Such a small number is insignificant in firms. It cannot be concluded that the volatility increases when a CEO are awarded with options of the company. It is possible that the executive s age plays a role in the volatility of the firm. Cool and Praag (2000) expected that younger managers are relatively more risk averse than older managers. This is because they are at the start of their career, and have not acquired yet a respected level of financial and human capital. According to the data, a CEO who is one year older will decrease the volatility with 0,206. With the significance level of it is acceptable to draw this conclusion. A possible explanation may be that an older CEO is more experienced and knowledgeable than a younger executive. There seems to be some evidence that the ratio of the total amount of assets divided by the total market value has an effect on the volatility. An increase of the assets-to-market value will lead to an decrease of the volatility with %. This seems to suggest that firms who have relatively more assets as a proportion of the total market value, have less volatility. However, the significance level is not really acceptable, Further research may find out whether a real relation exists between the asset-to-market ratio and the volatility The cash-to-market ratio has a large influence on the volatility. An increase of the cash-tomarket ratio with 0,01 will lead to an increase of the volatility of 0,39993%. This has a very good significance level of.000. According to Modigliani & Miller (1958), the level of investment should not be related to the amount of cash available in the firm. Earlier research from Hubbard (1998) found a positive relation between cash and investment expenditure. A possible explanation for the increased volatility is found in the agency theory. Jensen (1986) and Stulz (1990) suggested that the different interests of a CEO and a shareholder can cause this problem. Monitoring problems create an opportunity for the executive to spend the cash on projects which are beneficial for the manager, but not for the shareholders. As a result, managers can overinvest when there is enough available cash flow. And in turn, the volatility would rise when the available cash rises.

20 Also, the PPE-to-market value ratio (Property-Plant-Equipment) has an effect on the volatility. If the PPE-to-market ratio increases with 0.01, the volatility will increase with %. The significance level is very acceptable, This finding is the opposite of what was expected. According to Bhagat and Welch (1995) it is more likely that the volatility will decrease when the investment in Property Plant and Equipment increase. This is because PPE investments are typically seen as low-risk investments, which should decrease the volatility. Chapter 4: Conclusion The use of stock options has risen sharply to limit agency problems. Stock options should align the interest of the shareholder and the CEO. Their own wealth is more heavily tied to the performance of the firm when they are not only rewarded with a fixed cash salary, but also with a variable part like stock options. An increase of the firms performance will increase their own wealth, since a rise in the stock price will increase the value of the option. The hypothesis of this research is that managers take more risk, and increase the volatility to increase their own wealth. The hypothesis is not supported by this paper. There is no evidence that the use of stock options as compensation increases the volatility of the firm by creating incentives for the CEO. However, it cannot be concluded that the use of stock options doesn t affect the volatility at all. This study used S&P500 firms only and it tester only whether options owned from the previous year did have an effect on the volatility of the next. A possible explanation for the absence of an increased volatility can be found in the risk aversion of executives. From the agency perspective, a CEO whose remuneration is strongly tied to the firms performance will be more risk averse than the shareholders. The wealth of the CEO s is tied to the firm; they are not as much diversified as the shareholders can be. Because of this they can be relatively more risk averse, and will invest in safer projects and possibly don t invest in risky positive NPV projects. Giving the CEO options may be a tool to try to create an incentive to increase risk, since options then become more valuable. Shareholders want the CEO to take more risk because they are more capable to diversify their portfolio. This way shareholders can

21 offset risk themselves (Martin and Sayrak, 2003). May (1995) found that managers who have a large part of their wealth vested in the firm tend to follow more diversification strategies. A problem with stock options is that it doesn t reward the CEO perfectly for their performance. Luck also plays a large role. The growth rate differs between industries, and is also highly dependent on the rest of the economy. Bertrand and Mullainathan (2000) found evidence that CEO s are indeed paid for luck, rather than only performance. Also, Forbes magazine found that most S&P500 companies reward their CEO s on the basis of how other companies in the same industry sector remunerates. The data suggest that the age of the CEO plays a role in the volatility. An increase in the age of the CEO will lead to a decrease of the volatility. But it cannot be concluded that it is the age that has a direct influence on the volatility. Maybe older CEO s get positions in larger firms with a larger responsibility where less volatility is needed. A small change in volatility can lead to huge changes. And younger managers may get positions in smaller firms where more volatility is necessary. The age is then simply a byproduct, not a cause of the change in volatility The amount of cash available in the firm also has an influence of the volatility. There is evidence that some managers overinvest when there is a lot of cash available. This can create benefits for the executive, but not for the shareholders. (Jensen, 1986 and Stulz,1990) A remarkable finding of this paper is that more investment in PPE, will increase the volatility of the firm. However this is not what should be expected from earlier research from Bhagat and Welch (1995), because Plant Property and Equipment are normally regarded as safe investments. Further research should find an explanation for this finding. Although the hypothesis is not supported in this research, it is still very reasonable to assume that the use of stock options does increase the volatility. Managers also act in their own self interest, and it can be expected that they will increase their own wealth by increasing the volatility when they get the possibility. Finding an optimal balance between fixed and variable pay is difficult. It is not possible to state an optimal amount of stock options that should be rewarded because it is very firm specific. One should always bear in mind that it is not only material income (money) that changes the behavior of a CEO, but other personal factors like challenge, pride, freedom, resources.

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