The relationship between equity incentives for C-level executives and company performance has received enormous attention due to the cost to shareholders of the compensation awarded to top executives. An often neglected — but potentially more important — question is whether equity incentives influence executives’ risk-taking in ways that are detrimental to the company.
In a recent study, we undertook an in-depth analysis of the relationship between CEO equity incentives and strategic risk decisions in the life sciences sector, a sector in which executives typically receive a higher proportion of their compensation in equity incentives. This study offers unique insights to boards and the board subcommittees tasked with executive compensation and risk management. Most notably, we find that the equity incentives held by CEOs may induce bias in their recommendations with respect to major strategic decisions. To counter this bias, boards need to consider, in tandem, both the mix of equity incentives and the level of risk inherent in the decision.