Research Discussion Papers, Bank of Finland
No 19/2011:
Leverage and growth: effect of stock options
Bill Francis, Iftekhar Hasan ()
and Zenu Sharma
Abstract: This paper investigates the potential effects of stock
options on managers’ investment decisions and therefore on a firm’s growth
or, alternatively, on its leverage-growth relationship. To structure the
analysis addressing this issue, the paper utilizes a framework establishing
a negative relationship between leverage and the firm’s growth. However, in
contrast to some of the existing results, the empirical analysis of
manufacturing firms in this paper shows that the negative relationship
between leverage and growth has changed significantly. Primarily this paper
documents that, as options based compensation in manager’s portfolio
increases, the negative effect of leverage on growth disappears. The paper
argues that this is an important finding, because it implies that when
managers are compensated with options debt ceases to pre-commit managers.
On addressing the potential endogeneity problem between leverage, growth
and compensation the paper finds that option delta instead of book leverage
negatively affects growth, and that book leverage and option delta are
inversely related. Finally, the paper also examines the effect of corporate
governance on the relationship between leverage, incentives and the firm’s
growth and finds that leverage is negatively related to growth only in
poorly governed firms.
Keywords: leverage; stock options; compensation schemes; corporate governance; (follow links to similar papers)
JEL-Codes: C21; G32; G34; (follow links to similar papers)
58 pages, October 5, 2011
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