Stock Option Incentives and Corporate Hedging Decisions: Theory and Empirical Evidence

This paper examines how managerial risk‐taking incentives impact corporate hedging decisions. By nesting a well‐known corporate hedging model within a principal‐agent framework, we show that managers are motivated to maintain the same level of hedge intensity even if they are provided with stock option incentives. They are, however, motivated to add speculative positions on the downside to supplement their hedging operations. These predictions are verified empirically using separate measures for hedging and speculative activities. Our results contradict previous studies that suggest that managers hedge less of their firm's risk if they have stock option incentives.