We revisit the contentious relation between option compensation and managerial risk-taking
by studying how changes triggered by the elimination of favorable accounting treatment for
executive stock option grants (FAS 123R) affected hedging behavior in the oil and gas
industry. We hypothesize that a decrease in sensitivity of CEO wealth to stock return volatility
(vega) decreases CEO risk-taking incentives, causing affected firms to hedge more. We use
the FAS 123R compliance requirement to identify changes in CEO compensation vega that …

This study provides strong evidence of a causal effect of risk-taking incentives provided by
option compensation on corporate risk management. We utilize the passage of Financial
Accounting Standard (FAS) 123R, which required firms to expense options, to investigate
how chief executive officer option compensation affects the hedging behavior of oil and gas
firms. Firms that did not expense options before FAS 123R significantly reduced option pay,
which resulted in a large increase in their hedging intensity compared with firms that did not …