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Management Control - Papers Summary week 5
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Management Control Papers summary week 5Coles et al. 2006
This paper investigates the causal relationship between an important organizational feature,
the structure of managerial compensation and corresponding incentives, and value-critical
managerial decisions, specifically, those derived from both investment policy and debt
policy. This is done by researching whether CEOs that own better stock options adopt a
riskier debt and leverage position. This is because the assumption is made that when
managers are partially owner of the company, they will most likely be motivated to help to
company forward and the make sure it’s worth will increase.
The hypotheses of this paper are not super clearly formulated, but extracted from the text
the hypotheses are as below;
- Higher vega should lead to higher investment in R&D expenditures
- Higher vega should lead to lower investment in capital expenditures
- Higher vega should lead to increased firm focus
- Higher vega should lead to higher leverage
- Higher vega should lead to higher stock return volatility
-
Definition: Vega is the measurement of an option’s price sensitivity to changes in the
volatility of the underlying asset. Vega represents the amount that an option contract’s price
changes in reaction to a 1% change in the implied volatility of the underlying asset.
The results imply that higher vega is associated with higher R&D and lower capital
expenditures, or differently formulated, more investments in intangible assets over tangible
assets. Thus, CEOs with higher vega allocate investment dollars away from less risky capital
expenditures to more risky R&D. Furthermore, the effect of vega on investment policy
appears to be large and economically significant meaning that it has influence on it.
Furthermore, the results show that higher vega results in greater focus on a small number of
businesses rather than diversification across sectors.
With regards to leverage, it is stated that one way to increase risk is to increase leverage.
The results show that the influence of vega on leverage is economically significant and that
leverage depends on vega meaning that increased vega results in increased leverage.
Also the higher vega leads to higher stock return volatility according to the results. In sum,
all hypotheses are supported.
To support all of the above, the researchers found that CEO vega is the primary driving force
behind poliy choices while the rest of the management team’s vega is not. But on the other
hand, management team delta also affect policy decisions next to the CEO’s.
Concluded, there is a strong fundamental relationship between the structure of managerial
compensation (based on vega) and value-critical managerial decisions. It is shown that vega
is positively associated with their value-critical decisions. Also, a riskier policy leads to higher
vega and less risky policy to higher delta. All in all, the following three findings can be
highlighted;
- Managers take on riskier investments when granted with better stock options which
is because these options are typically granted at the money which means that the
value at the moment they get them is zero and cannot get any lower which results in
the manager taking on risky investments to increase value.
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