Non-Executive Employee Ownership and Corporate Risk

The Accounting Review • Issues in Accounting Education • Accounting Horizons
Accounting and the Public Interest • Auditing: A Journal of Practice & Theory
Behavioral Research in Accounting • Current Issues in Auditing
Journal of Emerging Technologies in Accounting • Journal of Information Systems
Journal of International Accounting Research
Journal of Management Accounting Research • The ATA Journal of Legal Tax Research
The Journal of the American Taxation Association
Online Early — Preprint of Accepted Manuscript

This is a PDF file of a manuscript that has been accepted for publication in an American
Accounting Association journal. It is the final version that was uploaded and approved by the
author(s). While the paper has been through the usual rigorous peer review process for AAA
journals, it has not been copyedited, nor have the graphics and tables been modified for final
publication. Also note that the paper may refer to online Appendices and/or Supplements that are
not yet available. The manuscript will undergo copyediting, typesetting and review of page proofs
before it is published in its final form, therefore the published version will look different from this
version and may also have some differences in content.
We have posted this preliminary version of the manuscript as a service to our members and
subscribers in the interest of making the information available for distribution and citation as
quickly as possible following acceptance.
The DOI for this manuscript and the correct format for citing the paper are given at the top
of the online (html) abstract.
Once the final published version of this paper is posted online, it will replace this
preliminary version at the specified DOI.
Non-Executive Employee Ownership and Corporate Risk
Francesco Bova
Joseph L. Rotman School of Management, University of Toronto
Francesco.Bova@rotman.utoronto.ca
Kalin Kolev
Yale School of Management
kalin.kolev@yale.edu
Jacob Thomas
jake.thomas@yale.edu
Frank Zhang
frank.zhang@yale.edu
preprint
April 30, 2014
accepted
Editor’s note: Accepted by John Harry Evans III.
manuscript
Submitted December 2012
Accepted June 2014
JEL classification: G30.
Keywords: Employee ownership, employee compensation, executive compensation, risk
We thank Mingming Qiu, Ilona Babenko, and Rik Sen for sharing data, and Joseph Blasi, Robert Bushman, Brian
Cadman, Yiwei Dou, Mary Ellen Carter, John Core, Richard Frankel, Wayne Guay, Rachel Hayes, Gilles Hilary,
Doug Kruse, DJ Nanda, Darius Palia, Robert Verrechia, Terry Warfield, and seminar participants at the 2012 AAA
Annual Meeting, University of Alberta Accounting Research Conference, Colorado Summer Accounting Research
Conference, Concordia University, London Business School, the Louis O. Kelso Fellowship mid-year meeting,
IAFEP Conference, INSEAD, University of Maastricht, University of Miami, the University of Toronto, and
University of Wisconsin for their valuable feedback. Bova and Thomas are grateful for funding from the Louis O.
Kelso Faculty Fellowship for research in employee ownership and Yale School of Management, respectively.
Non-Executive Employee Ownership and Corporate Risk
Abstract. Prior research documents a negative link between risk and executive holding of stock
but a corresponding positive link for options. We find a similar negative relation for non-
executive holding of stock. Our finding is consistent with the view that non-executives not only
face significant incentives to reduce risk when they hold stock, but they are also able to affect
corporate risk. While endogeneity cannot be ruled out fully, the results of a battery of tests
suggest that it plays a limited role. A second robust result is that the documented relation
becomes more negative as option-based executive compensation increases. Overall, corporate
risk is related to the incentives created by stock and options held by both executives and non-
executives, as well as interactions among those incentives.
JEL classification: G30.
Keywords: Employee ownership, employee compensation, executive compensation, risk
preprint
accepted
manuscript
I. INTRODUCTION
An extensive literature considers how different forms of compensation create incentives
for managers to alter the distribution of stock returns. A subset of that research focuses on
incentives to affect corporate risk, which is defined as the volatility of stock returns in an
efficient market, by actions that either increase volatility (e.g., invest in risky projects or increase
leverage) or decrease volatility (e.g., hedge exposure to operating risk). Prior research (Stulz
1984; Smith and Stulz 1985; Guay 1999) predicts a negative relation between stockholding and
stock volatility. The empirical evidence (May 1995) confirms that prediction. However, these
findings are based mainly on compensation paid to senior executives. We investigate whether the
negative relation between stockholding and stock volatility observed in prior research extends to
non-executive employees.
Our motivation is two-fold. First, we identify eight subgroups of research investigating

preprint
equity-based compensation, represented by the interaction among how holdings of stocks/options
accepted
create incentives for executives/non-executives to affect the first/second moment of returns. Of
manuscript
the eight subgroups, the incentives created by stock held by non-executives to affect the second
moment of returns have received the least attention. Second, the arguments for a negative
relation between risk and stockholding are weaker for non-executives than for executives,
because of the lower likelihood of satisfying two necessary conditions. The first condition is that
the fraction of an employee’s wealth, including human capital in the form of future
compensation, that is correlated with employer stock price has to be large enough to result in
significant incentives to reduce risk. The second condition is that employees have the ability to
alter risk, either by eliminating risky alternatives from consideration or by taking actions
subsequently to reduce volatility. We analyze why these conditions may or may not hold for non-
1
executives. Even though our research hypotheses are stated as if the conditions hold, we are
agnostic and “let the data speak.”
Prior research on the relation between corporate risk and managerial stockholding (Stulz
1984; Smith and Stulz 1985; Guay 1999) suggests that the relation will generally be negative.
While higher stock volatility increases the value of compensation that has a convex relation with
stock price, such convexity becomes relevant for stockholding only when firms are close to
financial distress. We believe that the same arguments apply to non-executive employees.
Importantly, higher stock volatility creates greater disutility for employees holding stock, relative
to outside shareholders. Employees are more risk averse because their human capital in the form
of future compensation is tied to the firm’s fortunes, and they are also less able to diversify, and
thus bear both systematic and idiosyncratic risk.
We use two measures of the dependent variable to reflect the extent to which employees
preprint
influence corporate behavior that affects stock volatility. Consistent with our definition of risk,
our first risk measure is the standard deviation of daily stock returns over the 12 months
accepted
following the disclosure of non-executive stockholding. To the extent that the market may not be
manuscript 1
fully efficient, stock volatility will represent a noisy measure of corporate risk. As an alternative
and potentially less noisy proxy, we use an accounting measure: the standard deviation of
seasonally-differenced quarterly accounting return on assets over the next 20 quarters. Finally,
we also consider other indirect measures of corporate risk, such as the level of R&D
expenditures.
Our main independent variable, employee stockholding, is derived from Form 5500 data
filed with the Department of Labor for defined contribution plans invested in employer stock.
1
One alternative is to replace observed stock volatility with volatility implied by put and call option prices. We
find similar results for a subsample with available option data. Section V contains robustness analyses that
investigate the extent to which our results are sensitive to alternative proxies for our variables.
2
These data cover retirement plans, for which employees are eligible to receive benefits at or after
retirement, including employee stock ownership plans and 401(k) plans, but exclude non-
retirement plans, such as restricted stock and stock purchase plans (see Frye 2004 for a
discussion of this taxonomy). Thus, while our measure does not encompass all employer stock
held by non-executive employees, it captures a significant portion of all involuntary holdings.
Non-voluntary holdings, which can be sold at any time, should create lower incentives to reduce
risk.
Recent studies such as Guay (1999) and Coles, Daniel, and Naveen (2006) use the vega
of executive wealth (options plus stock plus human capital) as the explanatory variable, while
controlling for delta. Vega and delta represent the sensitivity of managerial wealth to changes in
return variance and share price, respectively. Because the available data do not allow estimation
of delta and vega for non-executive wealth, we use the level of employee shareholding, stated as
a percentage of total shares outstanding. preprint

We consider a number of control variables including market capitalization, book-to-
accepted
market ratio, leverage, presence of tax loss carryforwards, and effective tax rates. To control for
manuscript
the incentives of senior executives to influence risk, we include the percentage of total shares
held by those executives and option awards as a percent of total compensation. While our main
results do not include controls for non-executive optionholdings because these data are not
available in Compustat before 2004, we include those controls for the subperiod with available
data to confirm that our inferences are not sensitive to this omission.
Because we cannot control for all relevant effects and the variables we use are likely
measured with error, we consider possible ways in which the omission of controls and
measurement error might negatively bias our estimated coefficient on non-executive
3
stockholding. We conduct extensive sensitivity analyses and conclude that any bias created by
the research design should work against our predictions.2
We find two robust relations. First, employee stockholding is strongly negatively related
to risk measures that are linked to increases in stock volatility. Second, this relation becomes
more negative as the level of executive optionholding increases. Taken together, our results
suggest that corporate risk is affected by both executive and non-executive stockholdings and
options, as well as by interactions among these holdings.3
With respect to causality, our first result is consistent with the view that higher
stockholding for non-executives significantly increases their incentives to reduce stock volatility,
and that these employees have the ability to take the necessary risk-reducing actions. This latter
inference is new to compensation research in accounting and finance. However, work in labor
economics and organizational behavior suggests that non-executives are directly and indirectly
preprint
able to influence corporate behavior, and that this influence increases with employee ownership.
In essence, employee ownership is most effective when combined with increased employee
accepted
participation, which results in increased cooperation, delegation, and responsibility sharing
manuscript
(Kamil, Pendleton, and Poutsma 2005; Foss 2003; Pendleton, McDonald, and Robinson 1995;
Blasi, Kruse, and Park 2010). Further, if higher executive optionholding creates incentives for
executives to increase risk, our second result is consistent with the view that the incentives for
non-executives to reduce stock volatility are heightened in cases where executives have greater
incentives to increase stock volatility.
2
For example, we should consider executive holdings, not annual grants, of options and should deflate stock and
option holdings by total wealth. Without data on senior executive wealth, we considered different combinations
of stock and option holdings and grants in the robustness analyses in Section V and different scaling variables.
The reported results reflect the two measures with the most significant coefficients on the control variables, to
reduce any potential negative bias associated with the coefficient on our measure of non-executive stockholding.
3
We assume that senior executives within the same firm face similar incentives to affect risk. Some prior
research, however, suggests that there are differences (e.g., between CEOs and CFOs in Chava and
Purnanandam 2010).
4
Prior research raises significant concerns regarding endogeneity affecting the associations
we document, as well as any causal inferences we draw. We focus on three common sources of
endogeneity (Roberts and Whited 2012): simultaneity, correlated omitted variables, and
measurement error. There are few exogenous variables in our analysis, and many variables are
determined jointly.4 Alternative explanations of the results include reverse causality and omitted
correlated variables. Finally, our coefficient estimates might be biased because the above-
mentioned measurement errors associated with regressors are related to either measurement error
associated with other regressors or the regression error.
We consider different approaches to address these concerns, both when we seek to
establish association and when we infer causal relationships. First, we use an instrumental
variables approach, where we model employee ownership in the first-stage regression. Second,
to control for potential omitted variables, we include lagged values of the dependent variables as
preprint
an additional explanatory variable. Surviving this hurdle should substantially increase the
robustness of our findings because it addresses many alternative explanations, including omitted
accepted
correlated variables and reverse causality. Finally, we examine cross-sectional variation in the
manuscript
relation between non-executive stockholding and risk along dimensions that might help us
eliminate alternative explanations for our results. We observe similar results for several
relatively independent approaches which increases the reliability of our inferences.
We believe we are the first to examine the link between non-executive employees and
corporate risk. Our main contribution is to document the two robust patterns we observe, and to
alert researchers that incentives created by equity-based compensation for non-executive
employees might also play an important role in corporate behavior. Consideration of non-
4
To the extent that actual compensation deviates from optimal compensation, for idiosyncratic reasons the
explanatory variables considered in our analyses are more likely to be exogenously determined. These
idiosyncratic reasons include unexpected changes in the factors that determine optimal compensation (Core and
Guay, 1999) and managers who override weak boards.
5
executive employees may be relevant even for studies focused on senior executives if, as our
results suggest, there are interaction effects between the two sets of incentives. Our results may
spur future work that develops a better understanding of causal relationships.
Section II next discusses prior research and develops our hypotheses. Section III
discusses the data and provides descriptive statistics. Section IV presents the main results and
Section V contains robustness checks. Section VI concludes.
II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
Executive stock and option holdings and risk: theory
Smith and Stulz (1985) and Stulz (1984) identify two opposing incentives in assessing
the impact of stock and option holdings on a manager’s desire to affect risk. The two incentives
relate to the two steps that link managerial utility to stock volatility. The first step connects
managerial utility to volatility in managerial wealth, and the second step connects managerial
preprint
wealth to stock volatility. The first incentive, which motivates managers to reduce risk, relates to
accepted
the first step above and reflects managerial risk aversion. Because risk-averse managers exhibit a
concave relation between utility and wealth,manuscript

volatility in the portion of wealth that is positively
related to stock price results in a risk premium, where the certainty equivalent amount of wealth
is discounted relative to mean or expected values of wealth. The portion of managerial wealth
that is positively related to stock price includes stockholding, optionholding, and any human
capital that is employer-specific.5
The second incentive, which causes managers to increase risk, arises when the second
relation between stock volatility and the portion of stock price-sensitive wealth is convex. Such
5
Incentives to reduce risk are also created by a different component of managerial wealth referred to as “inside
debt” (Anderson and Core 2012 and Cassell, Huang, Sanchez, and Stuart 2012), which includes unsecured
deferred compensation. Given the absence of data on inside debt for non-executives, we ignore incentives related
to such claims.
6
convexity in the second step operates counter to the first-step concavity created by risk aversion,
and can dominate the concavity effect if it is sufficiently strong. Convexity in the second step is
created by option-like features of equity-based wealth. Specifically, options that are close to or
below the exercise price and stocks that are close to financial distress when asset values
approach levels of debt exhibit convexity in the second step. In contrast, options that are deep-in-
the-money and stocks that are not close to financial distress exhibit little convexity.
Whether stockholding and optionholding create net incentives to increase or decrease risk
depends on the relative magnitudes of the two incentives. Given that the incentives to increase
risk are generally weak for managerial stockholding in firms not in financial distress, the
incentives to reduce risk are expected to dominate. For managerial optionholding, however, the
incentive to increase risk becomes more relevant, and the net effect varies from case to case
depending on the relative strengths of the two opposing incentives.6
preprint
Note that total stock volatility, both idiosyncratic and systematic, is relevant here.
Managers can reduce the impact of both types of risk on their holdings by judicious asset
accepted
allocation when investing their remaining wealth or by purchasing collars that eliminate both
manuscript
upside and downside risk. However, the maintained assumption in the literature is that a
substantial portion of the underlying exposure of managerial wealth to stock price volatility
remains unhedged at the personal level.7
Evidence on executive stock and option holdings and risk
6
Lambert, Larcker, and Verrecchia (1991), Carpenter (2000), and Lewellen (2006) illustrate why higher
optionholding might increase managers’ incentives to reduce stock price volatility, especially if the probability
of having options finish in-the-money is sufficiently high.
7
Empirical evidence provides support for this assumption. As an example, Hirshleifer, Low, and Teoh (2012)
document that firms with overconfident CEOs have higher return volatility and these CEOs are likely to continue
holding options past the vesting period.
7
Prior evidence supports the predicted negative relation between managerial stockholding
and incentives to take on more risk. For example, Tufano (1996) investigates a sample of
publicly-traded gold mines and finds that executives compensated with stock are more likely to
hedge gold price risk. Similarly, the findings in May (1995) suggest that executives with very
large stock holdings undertake risk-reducing acquisitions to better diversify assets.
The evidence on options-based compensation is mixed. While the early evidence suggests
that options generally create incentives to increase risk, more recent evidence suggests that
options do not create net incentives to increase risk. The early evidence includes Rajgopal and
Shevlin (2002), who show that the sensitivity of a CEO’s option-based pay to stock return
volatility for a sample of oil and gas producers is positively linked to the variability of future
cash flows from exploration activities. The more recent evidence includes Hayes, Lemmon, and
Qiu (2012), who show that the substantial reduction in option grants after 2006, when the
preprint
expensing of options becomes mandatory under SFAS 123R, is not associated with efforts by
managers to decrease risk.

accepted
More recent research combines stock and optionholding and estimates the sensitivity of
manuscript
managerial wealth to stock volatility. Guay (1999) measures the convexity of CEO compensation
by estimating the convexity contributed by a stock option or share of common stock as the
change in the security’s value for a one percent change in the annualized standard deviation of
stock returns. Guay (1999) finds that this measure of convexity, vega, is more meaningful for
firms with growth options, reflected by higher investments in R&D and capital expenditures.
Coles et al. (2006) and Low (2009) use the Guay (1999) measure and show that a higher
sensitivity leads to riskier policy choices, more investment in R&D, and increased total,
systematic, and idiosyncratic risk. Similarly, Armstrong and Vashishtha (2012) also document a
positive relationship between vega and a firm’s systematic risk.
8
Non-executive stock holdings and risk
Are the preceding results observed for executive stockholding also likely to be observed
for non-executive stockholding? As discussed earlier, even though stockholding should in theory
create incentives for all employees to reduce risk, there are a priori reasons to believe that the
same negative relation might not hold for non-executive employees. Levels of stockholding
might be low relative to non-executive employee wealth, resulting in low incentives to reduce
risk. Even if such incentives are strong, the rights to investment, financing, and operational
decisions may be retained by senior executives, leaving non-executives with limited ability to
reduce risk. Although we do not have strong prior beliefs about the actual incentives of
employees to reduce risk and their ability to do so, we present arguments below for why a
negative relation between non-executive stockholding and risk might be observed.
Regarding the question of whether non-executive stockholding is large enough to create
preprint
meaningful incentives to reduce risk, we note that about two-thirds of our sample firms have zero
employee stockholding, based on the Form 5500 data on retirement plans. For the remaining
accepted
firms with positive employee stockholding, we report two estimates below for levels of
manuscript
stockholding for the typical employee. We divide the value of stock held in retirement plans
from Form 5500 reports by the total number of employees from Compustat and obtain a mean
(median) stockholding per employee of $10,214 ($3,245). We obtain an alternative estimate by
dividing plan assets by plan participants for ESOP plans which results in a mean (median) of
$82,000 ($32,000). The first estimate is likely to be a lower bound for employee stockholdings
because many employees hold company stock outside of retirement plans (e.g., restricted stock
plans). The alternate estimate is likely to be an upper bound for employee stockholdings because
plan participants include retirees. Thus the average plan assets likely overstate the stock held by
active employees
9
We are unable to find reliable savings data for typical employees in our sample against
which to compare the preceding estimates of employee stockholding. However, more general
evidence (Browning and Lusardi 1996; Lusardi, Schneider, and Tufano 2011) suggests that
median savings levels are low.8 While savings levels increase with income, they are negative for
the first two quintiles of income and become high only for the highest quintile of earners. If so,
typical savings levels, particularly wealth held as financial assets, for employees in our sample
firms during our sample period are also probably quite low. We assume that total savings are of
the same order of magnitude as annual pay. Moving from total savings to the portion held as
employer stock, estimates in Blasi et al. (2010) for a sample of firms with positive employee
stockholding suggest that the average value of employer stock held is 65 percent of annual pay.
If so, the typical holding of stock may indeed be large enough, as a proportion of total savings, to
make employees sensitive to risk.9
preprint
Turning to the second question of whether non-executive employees are able to alter
corporate risk, we conclude that there is a sufficient basis to believe that corporate risk reflects
accepted
the preferences of non-executives. Specifically, we envision two non-mutually-exclusive
manuscript
mechanisms through which non-executives may affect corporate risk. 10
The first potential
mechanism assumes that a board seeking optimal contracts takes into account the different types
of corporate risk managed by executives and non-executives, respectively. Specifically,
executives determine strategic investment risk, such as selecting which project to invest in,
8
For example, Lusardi et al. (2011) examine households’ financial fragility by looking at their capacity to raise
$2,000 in 30 days. Using data from the 2009 TNS Global Economic Crisis survey, they document widespread
financial weakness in the United States because approximately one quarter of Americans report that they could
not raise $2,000 in the allotted time. The results suggest that, for the average American, even a $10,000
investment in company stock represents a large portion of their overall wealth.
9
Arguments could also be made for why non-executives are likely to be more sensitive to risk, relative to
executives. For example, the human capital of non-executive employees might be tied more closely to firm
performance, and non-executives might diversify less than executives because they are less sophisticated
investors and are likely to have less access to financial advisors.
10
We take no position on which mechanism is likely to dominate, as this is an issue outside the scope of the
present study.
10
whereas non-executive employees manage operational risk via careful implementation and
execution of executives’ decisions. Thus, consistent with prior research, the board grants
executives an ex ante optimal compensation package where stock options induce risk-taking in
search of higher returns. At the same time, the board grants non-executive employees stock to
mitigate operational risk, suggesting a negative correlation between employee stockholding and
corporate risk. Taken together, the employees’ careful execution of executive decisions reduces
overall corporate risk without sacrificing the mean payoff, leading to a higher reward-to-risk
ratio. Importantly, this structure also implies that, as executives take on more strategic risk, non-
executive employees have stronger incentives to mitigate operational risk, suggesting that the
negative association between employee stockholding and corporate risk increases in executive
risk-taking behavior.
The second potential mechanism reflects the idea that non-executive employees can
preprint
actually influence the firm’s strategic decisions. Specifically, non-executives may have the
capacity to filter or influence the menu of projects chosen by management. Thus, the seemingly
accepted
contradictory incentives induced by executive options and non-executive stock compensation
manuscript
translate into a decision-making process that mitigates the potential for excessive risk-taking.
This mechanism also suggests that non-executives’ incentives to reduce risk increase with
executives’ risk-taking behavior.
Consistent with both mechanisms, the labor economics and organizational behavior
literatures document evidence that firms often adopt employee ownership plans and increase
employee decision rights jointly. For example, Blasi et al. (2010) assesses data from the 2002
and 2006 General Social Surveys and the 2001 and 2006 NBER Company Surveys. That study
concludes that employees compensated with company stock are more likely to: a) be involved in
making decisions on the job and setting department goals; b) operate with minimal supervision;
11
c) have an increased say about what happens on the job; and d) make decisions cooperatively.11
Moreover, further evidence suggests that increased stockholding and optionholding results not
only in higher levels of cooperation, but also in more stringent monitoring of employees by
fellow employees (e.g., Fitzroy and Kraft 1986 and Hochberg and Lindsey 2010).
To assess whether there is anecdotal support for the notion that non-executives can
impact both operational and strategic risks, we interviewed several executives of publicly-traded
companies where non-executives have substantial stockholdings. We highlight the comments
from Steven Fisher, Senior VP and Treasurer of SAIC, a private company that was majority-
owned by its employees. 12 After SAIC went public (NYSE: SAI), employees divested most of
their holdings. As such, Mr. Fisher has observed variation in employee ownership over time and
is able to comment on the effect of that variation on firm outcomes. Mr. Fisher feels that an
equity stake for employees can impact corporate risk in two ways.
preprint
First, equity stakes for non-executive employees increase the level of effort and
commitment to implementing and executing the strategic decisions of executives. For example,
accepted
SAIC’s employee-owners worked hard to cross-fertilize cultures and integrate management
manuscript
following the acquisition of a target firm. By putting in extra effort to implement executives’
strategies, employee-owners at SAIC not only reduced integration risk, but also reduced the
volatility of SAIC’s subsequent returns. Second, equity stakes for non-executives increased the
breadth of participation in the firm’s strategic decision-making. For example, SAIC solicited
input from non-executive employees when contemplating which targets to acquire.
11
The General Social Survey assesses a national area probability sample of non-institutionalized adults. The survey
was conducted by the National Opinion Research Center of the University of Chicago in 2002 and 2006. The
NBER Company survey assesses data from employee surveys across 14 companies and 323 worksites in 2001
and 2006.
12
The transcript of the interview is available from the authors upon request. SAIC is only one of many anecdotal
examples of firms where employees directly affect corporate risk. For example, survey evidence finds that 41
percent of employees in employee-owned firms feel that they have an influence over the company’s strategic
decisions (http://www.ownershipassociates.com/ocr2.shtm).
12
Similar outcomes have been documented at other firms where non-executives own large
stakes in the company. United Airlines became majority-owned by its employees in the mid-90s
when the firm’s owners gave non-executive employees 55 percent of the firm’s equity.
Consistent with our conjectures, not only did the new employee-owners influence United’s
strategic decision-making, but being employee-owned appears to have diminished United’s
appetite for corporate risk. For example, United Airlines aborted its acquisition of US Air in
1995, specifically because of employee opposition to the acquisition (Faleye, Mehrotra, and
Morck 2006). Similarly, New Belgium Brewing, a firm majority-owned by its employees and the
focus of a recent documentary on employee ownership, solicited feedback from all of its non-
executive employee-owners while contemplating an expansion to North Carolina.13 Besides
providing non-executives with an opportunity to inform the firm’s strategic decisions, having an
equity stake in the firm apparently had a significant impact on the employees’ risk-taking
preprint
preferences. Specifically, employees appeared cautious about the prospect of expansion, with
several employees voicing concerns.

accepted
Overall, increased stockholding by non-executive employees can potentially both create
manuscript
incentives to reduce corporate risk and lead to greater decision rights for non-executives. The
mechanisms discussed above also suggest that non-executive employees have stronger incentives
to mitigate risk when executives are likely to take more risk. Thus, we state our research
hypotheses, in their alternative forms, as follows:
H1: Cross-sectionally, higher levels of non-executive employee stock ownership are related
to lower corporate risk.
H2: The negative correlation between employee stockholding and corporate risk increases
in the executives’ propensity to take on risk.
13
We the Owners, directed by David Romero, and produced by the Foundation for Enterprise Development, 2013.
13
III. SAMPLE AND DESCRIPTIVE STATISTICS
Sample
To obtain employee stock ownership data, we search the U.S. Department of Labor Form
5500 filings for defined contribution plans that allow direct investment in employer stock. As
described in Bova, Dou, and Hope (2013), we include “employee stock ownership plans
(ESOPs), 401(k) plans that allow an investment in employer stock as an option, deferred profit
sharing plans invested in employer stock, and employer stock bonus plans.” When there are
discontinuities in the data series for a firm, we impute the missing observation for year t as the
average of values obtained for years t-1 and t+1. To merge these data with Compustat, we
aggregate stockholdings across plan sponsors with the same Employee Identification Number
(EIN).
In concept, employee stockholdings should be measured as a fraction of employee

preprint
wealth. In the absence of data on employee wealth, we scale employee stockholding (EMPSTK)
accepted
by the number of shares outstanding as detailed in the Appendix. While this deflator could cause
manuscript
considerable measurement error, we believe the error would bias the estimated coefficient on
EMPSTK toward zero if other variables are measured correctly in the regression (Roberts and
Whited 2012). To verify that the choice of deflator does not drive our results, we explore
alternate proxies of EMPSTK in Section V. In particular, as an alternative to scaling EMPSTK by
outstanding shares, we consider the dollar value of stock holdings per employee. The sign and
significance levels for the coefficient on EMPSTK are unchanged when using this alternate
proxy.
Bova et al. (2013) describe the fractions of different types of plans, as well as the fraction
of total stock value held by those plan categories included in and excluded from EMPSTK. For
example, 29.7 percent of firms have ESOP plans while 83.4 percent of firms have non-ESOP
14
plans. However, ESOP plans account for 71.4 percent of the common stock held across all plans
in the sample while non-ESOP plans account for 28.6 percent of the common stock held across
all plans.14
While EMPSTK includes employee stock held in various retirement plans, it excludes
stock held in non-retirement plans, such as restricted stock and employee stock purchase plans.
For some firms, such as Apple, the fraction of total employee stockholding excluded from
EMPSTK is substantial. However, the exclusion of some employee stockholdings from EMPSTK
does not bias our findings in favor of H1. If the excluded holdings are unrelated to holdings
included in EMPSTK, the associated measurement error biases the coefficient on EMPSTK
toward zero. Even if the excluded and included stockholdings are positively related, the
magnitude of the negative coefficient on EMPSTK would be biased upward, but the magnitude
of the associated t-statistic should not be.
preprint
We next discuss the implication for our tests of stockholdings that are excluded from
EMPSTK. Omitting stock held voluntarily, as in employee stock purchase plans (ESPPs), is less
accepted
of a concern because employees could elect to sell those shares at any time.15 Employee holding
manuscript
of restricted stock, on the other hand, should create incentives similar to those created by plans
included in EMPSTK that require employees to hold stock. To investigate potential bias in the
estimate of EMPSTK, we examine the correlation between EMPSTK and restricted stock grants
(not holdings) for a 2005 sample obtained from Mingming Qiu at the University of Utah. The
correlation is 0.058, which we view as low. Additional empirical analysis suggests that the
14
In untabulated analysis we assess whether having an ESOP or non-ESOP plan affects our inferences. We
partition the sample of firms where EMPSTK>0 into sub-samples for firms with ESOP plans and firms with non-
ESOP plans. We continue to find a negative relationship between EMPSTK and risk-taking in both sub-samples.
15
Nevertheless, in untabulated analyses, we include stockholding held in ESPPs and find that the coefficient on
EMPSTK continues to be negative and significant in all models. We thank Ilona Babenko and Rick Sen for
allowing us to use the ESPP data hand collected for Babenko and Sen (2011). We do not include ESPP data in
our main EMPSTK variable for the tabulated analysis because fair market values for the stock held in ESPPs are
only available when they are voluntarily disclosed by firms. As a result, there are comparatively few firm-years
with data in the ESPP sample.
15
coefficients on EMPSTK are virtually unchanged when we include grants of restricted stock as
an additional variable in the regressions for year 2005. Overall, while EMPSTK likely measures
non-executive stockholding with error, we believe those errors bias the magnitude of the
coefficient on EMPSTK toward zero.
Our sample reveals few obvious patterns of industry clustering based on levels of
EMPSTK. For example, most technology firms have low levels of EMPSTK, where restricted
stock is not included in EMPSTK. Most industries have both firms with zero and with high levels
of EMPSTK. In particular, firms in the top 10 percent of EMPSTK, which include DuPont,
Guidant, Exxon, Abbott Labs, GE, AT&T, Kroger, Southwest Airlines, and Proctor & Gamble,
belong to a broad range of industries.
Even though our focus is on non-executive stockholdings, their optionholdings are also
likely to affect incentives to alter risk and should be controlled for. However, we are unable to
preprint
obtain option data for the earlier part of our sample period, as Compustat only provides data for
option variables beginning in 2004. Therefore while our main results exclude non-executive
accepted
optionholdings, we confirm that the negative relation between EMPSTK and the various risk
manuscript
proxies is robust to including estimates of option grants (EMPOPT), for the subperiod beginning
in 2004.
Because prior research documents a significant relationship between executive
compensation and risk, we also control for executive holdings of options and stocks using data
from Execucomp and Thomson Reuters, respectively. We scale shares held by executives
(EXESTK) and options granted to executives (EXEOPT) by total shares outstanding and total
executive compensation, respectively.
As alternative measures of EXEOPT based on options held by executives, we also
considered the number of options held, scaled by total shares outstanding; and the fair value of
16
options held, scaled by market value of equity. While option holdings should be more relevant
here than option grants, we find that the coefficient on EXEOPT is closer to zero for these
alternative measures of EXEOPT. To reduce the likelihood that the magnitude of the coefficient
on EMPSTK is overstated because the impact of EXEOPT is suppressed when we use these
alternative measures, we use the grant-based measure of EXEOPT. We see no reason why this
approach should inflate the magnitude of the estimated coefficient on EMPSTK.
After matching the Form 5500 data with Compustat, our sample contains 60,235
observations for 9,677 individual firms for the period 1999-2009. We next merge the data set
with Thomson Reuters Insider Filing data to gather information on executive stockholding,
EXESTK, which decreases the sample size to 18,417 observations for 5,371 individual
companies. Our sample size decreases further to 8,702 firm-years when we require information
on executive options EXEOPT from Execucomp, which generally covers only current and past
preprint
members of the S&P 1500. We obtain additional financial and market data from Compustat
Annual and CRSP, respectively. Because we use all available observations for each of our tests,
accepted
sample size varies across tests depending on the specific variables included. To mitigate the
manuscript
potential disproportionate influence of outliers, we Winsorize all continuous variables, other than
the three market-based variables (MV, SD_RET, and RET), at 1 and 99 percent of each year’s
cross-sectional distributions.
Risk proxies
The dependent variable should ideally be the portion of expected stock volatility that
reflects employee efforts to reduce risk. The first empirical proxy we use is observed future stock
volatility. We measure stock volatility as the standard deviation of daily stock returns (SD_RET)
17
over the 12-month period starting from the fifth month after fiscal year-end.16 Because prior
research calculates stock volatility in different ways (Chen, Steiner, and Whyte 2006; Core and
Guay 1999), we conduct robustness tests to confirm that our results are not sensitive to the
specific stock volatility measure used. For example, in Section V, we obtain similar results when
we repeat the analyses using idiosyncratic volatility, measured as the standard deviation of
market-model residuals over the same window, or implied stock volatility based on put and call
option prices, as of six months after the year-end.
Because stock volatility is affected by factors other than employees’ intent to influence
stock market volatility, such as unexpected revisions in discount rates and forecasts of future
cash flows, we consider the volatility of accounting rates of return (e.g., Beaver, Kettler, and
Scholes 1970) as an alternative empirical proxy. The risk measure we construct (SD_∆ROA) is
the standard deviation of seasonally differenced quarterly accounting return on assets over the
preprint
subsequent five years, where return on assets is income before extraordinary items, scaled by
average total assets for the quarter.

accepted
Prior literature also uses research and development expense (R&D) and capital
manuscript
expenditure (CAPEX) as proxies for risk. Whereas the incentive to increase risk is expected to be
positively related to R&D levels, arguments have been made for both positive and negative links
with CAPEX. The evidence confirms the positive relation expected for R&D, but both positive
(Guay 1999; Bargeron, Lehn, and Zutter 2010; Cohen, Dey, and Lys 2013) and negative (e.g.,
Coles et al. 2006; Hayes et al. 2012) relations have been observed for CAPEX. The negative
relation between non-executive stock ownership and our two primary risk measures, volatility of
stock returns and ROA changes, are also observed for R&D and CAPEX.
16
The five month lag allows the market to learn about a firm’s financial information. We obtain similar results
when using a four- or six-month lag.
18
Descriptive statistics
Table 1, Panel A, reports that the average (median) company in our sample has a market
capitalization of $4.2 billion ($484 million), consistent with our requirement for executive
compensation data skewing our sample toward larger companies. Employees hold on average 0.8
percent of the employer’s outstanding stock in retirement plans, reflecting the two-thirds of the
firm-years in our sample with zero EMPSTK. Company stock held by the top four executives is
on average higher (3.5 percent of shares outstanding) than for the stock held by non-executive
employees (0.8 percent of shares outstanding). For firms with positive EMPSTK, employees and
executives, on average, hold 2.7 and 2.3 percent of shares outstanding, respectively.17 Stock
option grants account on average for 31.4 percent of total executive compensation. As with
employee stockholding, there is considerable variation across the sample in both executive
stockholding and option grants.
preprint
Turning to the two primary risk measures, the mean (median) values for the standard
deviation of stock returns is 3.9 (3.1) percent, and 5.1 (2.1) percent for the standard deviation of
accepted
seasonally-differenced quarterly ROA. The remaining columns in Panel A, which describe the
manuscript
distributions for these two variables, suggest considerable cross-sectional variation.
<Insert Table 1 approximately here>
Table 1, Panel B, reports the Pearson and Spearman correlations between pairs of the
main variables of interest. Even though these correlations reflect the effects of other correlated
variables, they provide preliminary evidence on the relation between compensation and corporate
risk. Consistent with the conjecture that corporate risk decreases in non-executive stock
ownership, the Pearson and Spearman correlations between EMPSTK and the two risk measures
are significantly negative. Specifically, the Pearson (Spearman) correlations between EMPSTK
17
The result that the average executive stockholding is lower when EMPSTK is positive than for the full sample, is
consistent with the negative correlation we observe between EXESTK and EMPSTK in Table 1, Panel B.
19
and SD_ΔROA and SD_RET are −0.121 and −0.123 (−0.244 and −0.251), respectively.
Consistent with the results of some prior research (Rajgopal and Shevlin 2002), the proportion of
executive compensation attributable to option grants, EXEOPT, is positively related to both risk
measures. However, the proportion of shares outstanding held by executives, EXESTK, is also
positively correlated with SD_∆ROA and SD_RET, which is at odds with the negative relation
predicted by theory and documented in prior evidence (Tufano 1996; May 1995).
IV. RESULTS
We present our main results in this Section, and in Section V we explore a variety of
analyses designed to test alternative explanations for these results.
Employee ownership and corporate risk
To investigate whether non-executive employee stock ownership is associated with
preprint
reduced risk, we test for the conjectured negative relation predicted by H1 between future risk
measures (RISKt+1) and our measure of non-executive stockholding for year t (EMPSTK), using
the following regression model: accepted

RISKt +1 = β + β EMPSTK + β EXESTK + βmanuscript
0 1 2 EXEOPT + β Ln(MV ) + β BM
3 4 5
(1)
+β6CF + β7 NOL + β8 RET + Industry Fixed Effects + Year Fixed Effects + e
RISK represents the two primary measures of corporate risk, SD_∆ROA and SD_RET, as well as
the two additional measures we consider, R&D and CAPEX.18 We estimate the models using
ordinary least squares with errors clustered by firm (Petersen 2009).
Our main control variables are executive stock ownership (EXESTK) and option-based
compensation (EXEOPT). We include six additional variables identified in extant research as
important controls in analyzing the relationship between risk and compensation (Tufano 1996;
18
We consider both R&D and CAPEX in our primary regression model (Tables 2 and 7), but exclude them from
subsequent analyses. However, we confirm that the results hold for both variables in the additional analyses in
Tables 3-5.
20
Core and Guay 1999; Chen et al. 2006; Coles et al. 2006). Specifically, we include the log of
market value of equity (MV) at the end of year t, to control for potential economies of scale and
the cost of external financing.19 To account for growth and investment opportunities, we include
the book-to-market ratio (BM) for equity at the end of year t. We also consider leverage (LEV)
and free cash flows (CF) as measures of financial distress and capital availability, respectively.20
We define LEV as the three-year average of short-term and long-term debt, and CF as cash flow
from operations minus cash flow from investing and cash dividends (Core and Guay 2001). Both
variables are scaled by total assets and three-year averages are computed over years t−2 through
t. To control for the impact of the employer’s tax rate on compensation, we include an indicator
variable set to one if the company has a positive net operating loss carry-forward (NOL) in year t,
zero otherwise. Last, we control for the company’s stock return (RET) over year t. In untabulated
analysis, we further control for past ten-year stock returns (Benartzi 2001) and find our results
are virtually unchanged. preprint

To control for industry-specific and macro-economic factors, we include industry and
accepted
year fixed effects, where the industry classification is based on Fama and French (1997).21 The
manuscript
industry fixed effects act as additional controls, as the association between non-executive
employee ownership and corporate risk may vary across industries. For example, certain
industries require higher levels of non-transferrable, firm-specific human capital, while other
19
Because the market value of equity may not fully control for firm size, in untabulated analysis, we use sales
(Ln(S)) and the number of employees (Ln(EMP)) as additional control variables. In addition, to address potential
non-linear effects related to size, we include the square of Ln(MV), Ln(S), and Ln(EMP) in the regression. The
coefficients on EMPSTK remain significantly negative after including the additional size and non-linearity
controls.
20
We consider alternative proxies for financial distress and capital availability. For example, to capture cash flow
availability, we use interest burden, defined as the three-year average of interest expense scaled by operating
income before depreciation. We also consider alternative measures of financial flexibility including cash payout,
excess cash, and the cash flow measure including cash used for repurchase, where cash payout is defined as cash
dividend plus cash used for stock repurchases scaled by total assets, and excess cash is defined as cash and its
equivalents minus debt scaled by total assets. The main results remain qualitatively similar.
21
In untabulated analysis, we examine the effect of defining the industry fixed effects at the 2-, 3- and 4-digit SIC
levels. The coefficient on EMPSTK continues to be negative and significant for each risk measure.
21
industries are characterized by firms where employees perform non-routine tasks (Kotter 2013)
which may lead them to have more opportunity to affect corporate risk.22
Table 2 presents coefficient estimates for model (1). Consistent with Hypothesis H1,
EMPSTK exhibits a significant (at the 1 percent level) negative association with all four future
risk measures. These relationships are economically significant as well. Based on the Model (1)
results reported in column 1 of Table 2, the coefficient estimates imply that a one standard
deviation increase in EMPSTK in the current period is associated with a (0.077*0.023) / 0.051 =
3.47 percent decrease in SD_∆ROA during the next five years, expressed as a percent of mean
levels of SD_∆ROA. Similar calculations based on the results reported in column 2 imply that a
one standard deviation increase in EMPSTK decreases SD_RET, the volatility in the company’s
stock return in year t+1, by (0.027*0.023) / 0.039 = 1.59 percent of the mean levels of SD_RET.
preprint
Turning to the control variables, the coefficients on stock option grants for executives
(EXEOPT) are all significantly positive, suggesting that increased option grants for executives
accepted
are associated with higher corporate risk, ceteris paribus. The evidence regarding executive
manuscript
stockholding is mixed, however. The coefficient on EXESTK is negative and significant for
SD_∆ROA, positive and marginally significant for SD_RET and insignificant for the remaining
two risk measures. Untabulated analysis shows that, if we exclude EXEOPT from the
regressions, the coefficients on EXESTK are either significantly negative or statistically
insignificant.
22
This conjecture would be supported if the negative relation between RISKt+1 and EMPSTK were to become
stronger when industry fixed effects are dropped from equation (1). In untabulated analyses, we find that the
coefficients on EMPSTK are indeed more negative in the absence of industry fixed effects. We also find that
manufacturing and technology firms tend to have more negative coefficients on EMPSTK than agriculture,
financial, and service firms.
22
We confirm that the negative relation between EMPSTK and our two primary risk
measures is monotonic and not driven by a few observations with extreme values of EMPSTK.
Specifically, in untabulated analyses we compare the mean levels of the two risk measures for
low, medium, and high terciles, based on the distribution of EMPSTK each year, and note that
the differences in risk between the low and medium subgroups equal those between the medium
and high.23 We also repeat the analysis reported in columns 1 and 2 of Table 2 after replacing
EMPSTK with indicator variables that allow us to capture the mean risk for the three terciles,
after controlling for year and firm fixed effects. Again, the results suggest that mean levels of
risk increase monotonically in EMPSTK.
The interaction between non-executive and executive incentives
Our analysis so far assumes that the effects of stockholding for non-executive employees
and stock and optionholding for executives are independent. We consider next the possibility that
preprint
the relation between risk and EMPSTK varies with the level of EXEOPT as posited by
accepted
Hypothesis H2. Specifically, the discussion in Section II suggests that the relation between risk
manuscript
and EMPSTK is stronger for higher levels of EXEOPT. If the executive and non-executive
compensation packages are set optimally to induce more cooperation and a better system of
checks and balances, then as executives take more risk, non-executive employees have stronger
incentives to limit those risks, which suggests a negative coefficient on EMPSTK*EXEOPT. For
completeness, we also include the interaction between EMPSTK and EXESTK although we do
not have an ex ante expectation for the sign of this coefficient. The regression model we use to
test Hypothesis H2 adds these two interactions to equation (1):
23
We create terciles by including all firm-years with a value for EMPSTK equal to zero in the first tercile. We then
divide all firm-years with strictly positive values for EMPSTK equally between the second and third terciles.
23
RISKt +1 = β0 + β1EMPSTK + β2 EXESTK + β3 EXEOPT + β4 EMPSTK * EXESTK
+ β5 EMPSTK * EXEOPT + β6 Ln(MV ) + β7 BM + β8CF (2)
+ β9 NOL + β10 RET + Industry Fixed Effects + Year Fixed Effects + e
The main inference from the regression results in Table 3, Panel A, is that the coefficient
on β 5 , the EMPSTK*EXEOPT interaction, is negative and significant (at the 1 percent level) for
both risk measures. As conjectured, the relation between non-executive employee stockholding
and risk becomes increasingly negative as the level of options granted to senior executives
increases. The estimate of −0.309 for β 5 in column 1 implies that a one standard deviation
increase in EXEOPT is associated with an increase in the reduction of risk attributable to
employee stockholding of −0.0803 (= −0.309*0.260). That reduction in risk is more negative
than the −0.077 reported in column 1 of Table 2, which represents the average reduction in
SD_∆ROA associated with increases in employee stockholding across all levels of EXEOPT.
preprint
Similar calculations for SD_RET from column 2 suggest that the corresponding economic
magnitude is −0.030 (= −0.116*0.260). This value is more negative than the −0.027 reported in
accepted
column 2 of Table 2, which represents the average reduction in SD_RET associated with
manuscript
increases in employee stockholding across all levels of EXEOPT.
The coefficient on the EMPSTK*EXESTK interaction, β4, is also negative, but generally
insignificant. Notably, while allowing for interaction effects with executive compensation causes
the coefficient on EMPSTK to decline substantially from Table 2 to Table 3, the coefficients on
both EXESTK and EXEOPT remain relatively unchanged. Although increases in the level of
executive optionholding increase the negative relation between employee stockholding and risk,
changes in levels of employee stockholding have no effect on the impact of executive
optionholding and stockholding on risk.
24
To provide a more intuitive interpretation of the interaction between non-executive
stockholding and executive optionholding, Table 3, Panel B, reports the results of estimating the
relation between risk and EMPSTK for low, medium, and high levels of EXEOPT. The two
indicator variables, MEDEXEOPT and HIGHEXEOPT, are set to 1 for the middle and highest terciles
of EXEOPT, respectively, based on the distribution of EXEOPT each year. The negative
coefficients on the interaction between EMPSTK and MEDEXEOPT (EMPSTK and HIGHEXEOPT)
describe the extent to which the coefficient on EMPSTK becomes more negative as the level of
EXEOPT moves from the bottom tercile to the middle (highest) tercile. Turning to the regression
results, the relation between risk and EMPSTK becomes more negative and the associated
statistical significance increases for the low/high EXEOPT comparison, relative to the
low/medium comparison, for both risk measures.24 These results confirm the robustness of the
interaction effect documented in Panel A.
preprint
The empirical evidence presented in Tables 2 and 3 is consistent with the predictions of
accepted
H1 and H2 that higher levels of non-executive employee ownership of stock increase the
manuscript
incentives for those employees to take actions that reduce corporate risk and these risk-reducing
incentives increase further when optionholdings of executives are higher. The latter result is also
consistent with the notion that non-executive stockholdings lead to reduced risk primarily in
those settings where executives are incentivized to take on more risk.
V. ADDITIONAL ANALYSIS AND ROBUSTNESS CHECKS
We acknowledge that the models we estimate so far rely on a number of assumptions that
may not hold. For example, we assume that the level of non-executive stockholding is
24
The differences in coefficients between EMPSTK*HIGHEXEOPT and EMPSTK*MEDEXEOPT are marginally
significant, with each value having p-values just below 10 percent for the SD_ΔROA and SD_RET regressions,
respectively.
25
exogenously determined. Further, we do not consider reverse causality, where the level of stock
volatility is exogenous and determines levels of stock granted to non-executive employees.
Similarly, we cannot rule out the possibility that omitted variables determine both the level of
non-executive stockholding and stock volatility. For example, firms with more loyal employees
and longer tenure could have higher employee stock ownership and more stable performance.
We next consider a variety of analyses that investigate these alternative explanations.25 After
presenting our results, we review the extent to which the different alternative explanations are
supported or rejected.
The instrumental variables approach
To relax the assumption that EMPSTK is determined exogenously, we re-run the analysis
in a Two Stage Least Square (2SLS) framework. Specifically, we search for instrumental
variables that are related to EMPSTK in the first stage and then use the predicted value of
preprint
EMPSTK in the second stage, where we estimate the model of risk measures described by
accepted
equation (1). Successful implementation of the 2SLS estimator depends critically on the
manuscript
identification of instrumental variables correlated with EMPSTK, but not correlated with the
error term in the second-stage model (Greene 2003).
Theory suggests that firms grant employees stock for tax and employee retention
considerations. In particular, the effective tax rate has been shown to be an important driver for
the adoption of employee stock ownership plans (Beatty 1994, 1995). Following Dyreng,
Hanlon, and Maydew (2008), we use the five-year cash outlay for tax, scaled by pre-tax income
excluding special items (CASHETR).
25
In this Section, we consider multiple approaches to address the potential endogeneity of EMPSTK, which is our
main variable of interest. While EXESTK and EXEOPT are also likely to be endogenous, these variables enter
our analyses only as controls; hence, we do not attempt to model them. To the extent that the same underlying
factor determines EMPSTK, EXESTK, and EXEOPT, the inclusion of EXESTK and EXEOPT as controls in the
regression models helps to address the potential endogeneity of EMPSTK.
26
To incorporate employee retention, we consider two region-specific factors: the firm’s
“local beta” (LOCBETA) and enforceability of non-competition agreements (NCOMPENF). The
use of LOCBETA is motivated by arguments that a company’s stock price is correlated with the
employees’ outside opportunities. Thus, as equity compensation serves as an employee-retention
tool, the propensity to use an employee stock ownership plan to compensate employees might be
related to the comovement of the employer’s share price with that of competing employers in the
area (Kedia and Rajgopal 2009; Oyer 2004; Oyer and Schaefer 2005; Pirinsky and Wang 2006).
NCOMPENF reflects the idea that non-competition agreements limit the employees’ job
mobility, effectively serving as a retention device. Following Kedia and Rajgopal (2009), we
measure NCOMPENF as the non-competition enforceability index in Garmaise (2011). Our
maintained assumption is that these tax and employee retention consideration proxies do not
directly affect corporate risk other than through the employee channel. 26
preprint
The first stage of the 2SLS model takes the form:
EMPSTK = θ 0 + θ1CASHETR + θ 2 LOCBETA + θ 3 NCOMPENF + e (3)

accepted
manuscript
Using estimated coefficients from equation (3), we calculate P_EMPSTK, which is the predicted
value of EMPSTK, and substitute it in equation (1) to get the following second stage model:
RISKt +1 = β0 + β1P _ EMPSTK + β2 EXESTK + β3 EXEOPT + β4 Ln(MV ) + β5 BM

(4)
We report results for the first and second stages of the 2SLS analysis in Panels A and B,
respectively, of Table 4. All three instruments in Panel A are significantly related to EMPSTK.
Specifically, firms with higher levels of stockholding for their non-executive employees are
associated with higher effective tax rates and higher co-movement of stock prices with those of
26
CASHETR may not be a good instrumental variable if it directly affects corporate risk via channels other than
employee stock ownership. In untabulated analysis, we exclude CASHETR from the first stage regression and
find qualitatively similar results. F-value is 32.74, which is larger than the benchmark of 11.59, suggesting that
LOCBETA and NCOMPENF do not impose a weak-instrument problem (Larcker and Rusticus 2010).
27
local competitors, and are domiciled in states where non-competition agreements are less likely
to be enforced. The F-value from the first stage regression is 63.68, which is higher than the
benchmark of 12.83 with three instrumental variables, suggesting that the model does not suffer
from a weak-instrument problem (Larcker and Rusticus 2010). Results for the second stage,
reported in Panel B, are qualitatively similar to the OLS results reported in Table 2: consistent
with H1, the level of non-executive stock ownership is significantly negatively associated with
both risk measures.27
Controlling for lagged dependent variables
Another technique used to address endogeneity issues, especially omitted correlated
variables and reverse causality, is to include the lagged value of the dependent variable as an
additional control. The underlying logic of this methodology is that the lagged dependent
preprint
variable absorbs the effects of omitted correlated variables and reverse causality, provided they
accepted
remain relatively stable. We note that this approach biases against finding support for H1,
manuscript
because the lagged dependent variable suppresses the contribution of EMPSTK, if it is also
relatively stable over time. Overall, observing significant coefficients on EMPSTK in the
presence of controls for lagged values of the dependent variable, increases considerably the
likelihood that our main result is due to the factors underlying H1 rather than the many
alternative explanations we consider, especially those based on omitted correlated variables or
reverse causality.
In Table 5 we present the regression for equation (1) after including the lagged value of
RISK as an additional control. Lagged SD_ROA is computed over the prior five years, t-4 to t,
whereas lagged SD_RET is computed for year t. As expected, the coefficients on the lagged
27
P_EMPSTK has a mean of 0.012 and standard deviation of 0.005.
28
dependent variable are positive and have large t-statistics. The deviation of those coefficient
estimates from one is likely due to underlying mean reversion in the risk measures. More
relevant to H1, the coefficient on EMPSTK remains negative and significant (at the 1 percent
level) in both specifications. Thus, even though including lagged risk measures, which reflect the
effects of lagged values of both included and excluded regressors, reduces the estimated
coefficients on EMPSTK (relative to those reported in columns 1 and 2 of Table 2), the
remaining effect is statistically and economically significant. Also, we continue to observe
significant positive coefficients on EXEOPT across both risk measures.
Cross-sectional variation in the impact of non-executive employee ownership
Another approach we consider to address endogeneity concerns is to investigate cross-
sectional variation in the estimated coefficient on EMPSTK, β1 from equation (1), in settings
preprint
where β1 should vary predictably. In Table 3, we already document that β1 becomes more
accepted
negative with increases in the level of option-based compensation paid to executives. We
consider next the extent to which β1

manuscript
varies with the fraction of independent directors, a proxy
used in prior research for the quality of governance (e.g., Klein 2002; Rosenstein and Wyatt
1990). Specifically, we conjecture that strong boards, with more independent directors, provide
an alternative mechanism to protect non-executive stakeholders.28 We also conjecture (and
confirm below for our sample) that compensation for such executives is likely to be tilted more
toward options, relative to stock-based compensation. As a result, the incentives for non-
executive employees to reduce risk as their stockholding increases (captured by the coefficient
β1) should be even greater for firms with weak boards.
28
It is also possible that employees seek greater risk reduction when senior executives ignore weak boards, because
the behavior of senior executives is less predictable.
29
We partition our sample at the median level of independent directors each year, and
assume that firms above (below) the median, labeled as high (low) corporate governance
partitions, are associated with strong (weak) corporate governance. We first check whether firms
with strong governance have lower mean and median levels of option-based compensation for
senior executives. Consistent with our conjecture, the mean value of EXEOPT for the strong
(weak) governance partition is 34.01 (36.35) percent of total compensation for senior executives,
and the corresponding median value is 31.43 (34.34) percent. The results on cross-sectional
variation in the coefficient on EMPSTK (Table 6) are consistent with H1: the estimate of β1 is
substantially more negative for firms with fewer independent directors, relative to that for the
high governance partition, for both risk measures.
In a second cross-sectional analysis we test whether the relation between EMPSTK and
preprint
risk varies with the degree of employee sophistication. The intuition underlying this analysis is
that “Google engineers” should have greater ability to affect corporate risk than “Home Depot
accepted
manuscript
sales associates.” We use SG&A per employee as a proxy for wage per employee, relying on the
premise that “Google engineers” have higher wages than “Home Depot sales associates.”
Although SG&A includes items other than wages, we believe that SG&A per employee is a
reasonable proxy for the level of employee wages and sophistication. We define an indicator
variable, SGAdummy, which takes a value of 1 if SG&A per employee is above the sample
median value and 0 otherwise. Finally, we interact SGAdummy with EMPSTK in Equation (1).
Estimated coefficients on the EMPSTK*SGAdummy interaction term are −0.135 and −0.021
(which are significant at the 1 and 20 percent levels) for the SD_ΔROA and SD_RET regressions,
respectively. These results, suggest that the negative correlation between EMPSTK and risk
increases with employee sophistication.

30
Robustness analysis
We consider a number of analyses to determine whether our results are robust to
alternative ways of measuring our dependent and independent variables, as well as alternative
regression specifications.29 The results of some of those analyses are summarized below.
Our main independent variable, EMPSTK is measured as employee stockholding, scaled
by the number of shares outstanding. As an alternative specification motivated by the analysis in
Bova et al. (2013), we consider the logarithm of one plus the dollar value of employer stock held
per employee. Untabulated results show that our findings continue to hold with this alternative
specification. For example, focusing on the SD_ΔROA implementation of equation (1), the
coefficient on EMPSTK is −0.700 (p-value less than 1 percent), which is comparable to the
estimate of −0.077 (p-value less than 1 percent) reported in column 1 of Table 2, based on the
original measure of EMPSTK.30

preprint
For EXEOPT, we also consider total options held by senior executives, scaled by
outstanding shares, and the dollar value of total options held, scaled by market value of equity.
accepted
manuscript
Whereas theory calls for optionholdings, rather than option grants, our results suggest that the
alternative variables based on optionholdings are associated with greater measurement error. We
find that the magnitude and significance of the coefficients on EXEOPT in Table 2 and Table 3
decline when we use these alternative measures of EXEOPT. We interpret this decline as
suggesting that the greater measurement error associated with these alternative measures biases
29
As another robustness check, we examine if the EMPSTK effect changes post the Sarbanes-Oxley (SOX)
legislation. If firms generally lower their risk in response to SOX, then there is lower incentive for employees to
reduce risk, suggesting the relationship between EMPSTK and corporate risk should diminish in the post-SOX
period. We find partial support for this argument. Specifically, the coefficient on the interaction term between
SOX and EMPSTK is significantly positive in the SD_RET regression and statistically insignificant in the other
three models. In another robustness check, we control for institutional ownership and find that our inferences
remain unchanged. Compared with the results in Table 2, the coefficients on EMPSTK are slightly stronger in the
SD_∆ROA and SD_RET regressions and largely unchanged in the R&D and CAPEX regressions after controlling
for institutional ownership.
30
Whereas the magnitudes of the coefficients are not comparable, as the variables are defined differently,
comparison of the t-statistics and p-values is meaningful.
31
the otherwise strong positive relation between risk and EXEOPT towards zero.31 Consistent with
our view that increased error weakens our ability to capture the effect of executive
optionholdings, we observe a stronger effect for non-executive employee stockholdings,
reflected in higher magnitude and significance of the coefficients on EMPSTK. It is possible that
the greater measurement error we observe for alternative measures of EXEOPT is due to a
mismatched scaling variable. Theory calls for optionholdings to be scaled by total executive
wealth, which is not easy to estimate. Therefore, our robustness analyses should not be
interpreted as suggesting that option grants are preferable to optionholdings in compensation
research. Our results suggest instead that, for the scaling variables available to us, option grants
appear to measure the underlying variable of interest with lower error.
We also consider alternative measures for our dependent variable that are based on
expected, rather than observed, stock volatility. In particular, we estimate the average implied
preprint
volatility from put and call options on contracts with the same strike price. We use data as of six
months after the fiscal year-end and limit our sample to contracts with a six-month expiration
accepted
and the smallest amount of in-the- and out-of-the-moneyness. When we replicate the analyses in
manuscript
Table 2 and Table 3, we find estimated coefficients similar to those observed for SD_RET.
In addition to considering the impact of measurement error associated with our variables,
we also conduct other analyses designed to confirm the robustness of our two main results. For
example, we separately examine the subsample of observations with positive employee
ownership to address the concern that our main results are unduly influenced by the large
fraction of our sample with zero employee ownership. Table 7 presents the results from
estimating equation (1) on the subsample of 4,204 firm-years with positive EMPSTK. Similar to
31
It is possible that option grants, which are typically at-the-money, better reflect convexity in the relation between
employee wealth and stock price volatility, relative to option holdings, which may include substantial amounts of
options that are deep-in-the-money.
32
our Table 2 results, we find that the coefficients on EMPSTK are significantly negative across all
four risk measures.32
To investigate the robustness of our finding that non-executive employees have the
ability to influence stock volatility, we consider a case where we expect non-executive
employees to take actions to alter risk in response to exogenous shocks. Specifically, we consider
shocks to housing prices. Assuming that non-executive employees are risk averse on average, the
intuition underlying H1 predicts that a decrease in housing prices increases the incentives for
non-executive employees to reduce risk because of an increase in the fraction of total wealth that
is positively correlated with stock prices. Symmetrically, we expect the opposite effect when
housing prices increase. One reason for the increase in the fraction of stock-price-sensitive
employee wealth is that a decline in home values increases the relative fraction of total wealth
preprint
held in equity-based compensation. Another reason is our conjecture that employees become less
mobile after housing price declines, which then increases the positive correlation between human
accepted
capital and the employer’s stock price, thereby increasing the sensitivity of total employee
wealth to stock price volatility.

manuscript
To study the impact of housing-price changes, we replace EMPSTK in equation (1) with
changes in the residential housing price index (∆HPI). We measure changes in housing prices by
computing the annual percentage change in the residential house price index for the state where
the firm is headquartered. To capture the impact of changes in housing prices, the dependent
variable should reflect changes in the incentives to reduce risk, and models of risk changes
32
We also examine whether the relationship between EMPSTK and our risk taking proxies are non-linear by
including a squared EMPSTK term in the model. We find very limited evidence of non-linearities (the square
term loads with a weak positive coefficient for only two of the risk-taking proxies – SD_∆ROA and R&D). We
also note that, while the relationship between EMPSTK and both SD_∆ROA and R&D is convex, this convexity
never results in a positive relationship between EMPSTK and SD_∆ROA.
33
should include changes in all the independent variables in equation (1). As some of our variables
are measured over extended periods that will overlap when we take first differences, we include
the lagged value of risk measures as an additional regressor, rather than transforming equation
(1) to replace levels with first differences. Specifically, we estimate the following model:
RISKt +1 = β0 + β1RISKt + β2 ΔHPI + β3 EXESTK + β4 EXEOPT + β5 Ln(MV ) + β6 BM

(5)
We report the regression results in Table 8. The coefficient on ∆HPI in columns 1 and 3
is positive but insignificant for both risk measures, providing only weak support for H1. We next
investigate whether the relation between changes in risk and housing price changes varies over
time depending on the level of housing prices. Specifically, we repeat the analysis allowing for a
different relationship during the housing boom period: 2004 – 2007. Our motivation for this test
is to incorporate the possibility that employee risk aversion is lower during the housing boom, as
preprint
evidenced by lower down-payments and riskier mortgages.33 If the conjectured relationship
holds, we expect the coefficient on housing price changes to imply a smaller impact on the
accepted
employee incentives to reduce risk during the boom period. To test this relationship, we modify
manuscript
equation (5) to include an interactive variable (=ΔHPI*BOOM), where BOOM is an indicator
variable that is set to 1 for years 2004 through 2007. The results in columns 2 and 4 suggest that
the coefficients on ∆HPI are close to zero during the 2004-2007 housing boom period (indicated
by the sum of the coefficients on ΔHPI and ΔHPI*BOOM), but significantly positive during the
remaining years of the sample period. We view these results as supportive of H1.34
33
The desire to avoid risk could decline for a number of reasons during this period, as housing prices increased
steadily. For example, employees might underestimate subjective probabilities of downside scenarios. It is also
possible that corporate risk was deemed less important, as the relative fraction of employee wealth related to
housing (employer stock price) increased (declined).
34
In untabulated analysis, we include EMPSTK and the interaction between EMPSTK and BOOM in the regression.
We find that the coefficient on EMPSTK*BOOM is positive and marginally significant in the SD_RET
34
To summarize, the analyses described in Section V, which represent our best efforts to
investigate the three sources of endogeneity described in Roberts and Whited (2012) -- omitted
variables, simultaneity, and measurement error -- do not reveal reasons to invalidate our
conclusions relating to H1. Although such concerns cannot be eliminated fully, we believe that
the portfolio of tests we present reduces the likelihood that our results are spurious, as any
validity threats should have surfaced somewhere in the large number of supporting analyses we
conduct.
Simultaneity, and reverse causality in particular, are important concerns for us. We
believe, however, that finding significant results when we include lagged values of the dependent
variable as an additional regressor allays much of those concerns. If stock volatility determined
preprint
levels of employee stockholding, why would employee stockholding continue to explain future
stock volatility even after controlling for contemporaneous stock volatility? Also, it seems
accepted
unlikely that reverse causality from stock volatility to employee stockholding would explain the
results for volatility of accounting rates ofmanuscript

return, the other primary dependent variable we
consider. Similarly, we believe that our Two Stage Least Squares implementation offers
independent supporting evidence that simultaneity is less likely to be the driving force here.
VI. CONCLUSION
This study investigates the relation between stock held by non-executive employees and
corporate risk. Prior research finds this relation to be negative for senior executives, which is
consistent with risk-averse executives attempting to reduce the volatility of the portion of their
wealth that is related to stock prices. We investigate whether a similar negative relation is
specification and insignificant in the SD_ΔROA one, partially supporting the idea that employees mitigate risk
less when times are good.
35
observed for non-executive employees, based on the assumptions that these employees also have
incentives to decrease risk when stockholding increases, as well as the ability to take actions that
reduce corporate risk.
Consistent with that hypothesis, we find that the greater the amount of company stock
owned by non-executive employees, the lower the firm’s subsequent risk. Probing further, we
find that this relationship is more pronounced when senior executives are compensated more
with option-based pay, which appears to increase the incentives for managers to take on risk.
Finally, we find that these two results survive a battery of careful attempts to control for potential
endogeneity. A limitation of our results is in order. While we propose several alternative
mechanisms that may drive the relationship between EMPSTK and corporate risk, we are unable
to conclusively identify which mechanism dominates. Thus, identifying the dominant mechanism
through which employee ownership affects corporate risk represents a path for future research.
preprint
The collective evidence suggests that the risk preferences of non-executive employees
have an impact on subsequent corporate risk. As with most studies in this literature, endogeneity
accepted
cannot be completely ruled out. Thus, inferences from our evidence about the validity of our
manuscript
explanation should be viewed as a platform for future analysis. Our main contribution is in
documenting two robust associations that are new to the literature. First, we find a strong
negative relation between non-executive stockholding and corporate risk. Second, we find a
consistent interaction between that negative relation and the level of executive optionholding.
This latter interaction provides some of the first evidence that non-executive stockholding may
mitigate risk-taking in those environments where executives are incentivized to take on greater
risk.
36
Appendix: Variable Definitions
Variable Description*
EMPSTK Employee stock ownership as a percentage of shares outstanding in year t.
Data are obtained from Form 5500 filings for defined contribution
(retirement) plans invested in employer stock. Includes employee stock
ownership plans, 401(k) plans, deferred profit sharing plans, and employer
stock bonus plans. Excludes non-retirement plans, such as restricted stock
plans and employee purchase plans.
EMPOPT The fair value of options outstanding, estimated using the Black-Scholes
model and Compustat data, minus fair values of options held by executives
(from EXECUCOMP), scaled by the market value of equity.
EXESTK Stock ownership of senior executives, as a percentage of the shares

outstanding in year t, where stock ownership includes both the direct and
indirect shares held by the top four managers (Chairman of Board, Chief
Executive Officer, Chief Financial Officer, and President). Data obtained
from Thomson Reuters Insider Filing.
EXEOPT The value of option awards as a percentage of total compensation (TDC1)
from the EXECUCOMP annual compensation table in year t, where both
preprint
option awards and total compensation are summed across all executives
covered by EXECUCOMP. Most firms report the top five executives,
although EXECUCOMP collects data for up to nine executives for some
firm-years.
SD_∆ROA accepted
The standard deviation of seasonally differenced quarterly return on assets
manuscript
over the next five years (t+1 to t+5), where return on assets is measured as
income before extraordinary items (IBQ) scaled by average total assets
((ATQt + ATQt-1)/2).
SD_RET The standard deviation of daily stock returns for the 12-month period
starting from the fifth month after fiscal year-end.
R&D Annual research and development expense (XRD) scaled by sales (SALE)
in year t+1.
CAPEX Annual capital expenditure (CAPX) scaled by net property, plant, and
equipment in year t+1.
MV The market value of equity (CSHO*PRCC_F) at the end of year t.
BM The book-to-market ratio (CEQ/( CSHO*PRCC_F)) at the end of year t.
37
LEV Leverage, measured as the three-year average of short-term and long-term
debts, scaled by total assets ((DLCt + DLTTt) / ATt) from year t-2 through
t.
NOL Net operating loss, measured as an indicator variable equal to one if the
firm has positive net operating loss carry-forwards (TLCF) in year t.
CF Cash flow, measured as the three-year average of cash flow from
operations minus cash flow from investing and cash dividends, scaled by
total assets ((OANCFt – IVNCFt – DVt) / ATt from year t-2 through t.
RET Return on the firm’s stock in fiscal year t.
CASHETR The long-run cash effective tax rate, computed as the sum of income tax
paid (TXPDt), divided by the sum of a firm’s pre-tax income (PIt), less
special items (SPIt) over the previous five years.
LOCBETA The local beta βLOC is estimated using the following time-series regression
over 1999-2007 for each firm:
ܴ௜௧ ൌ‫ן‬௜ ൅ ߚ௜௅ை஼ ܴ௧௅ை஼ ൅ ߚ௜ெ௄் ܴ௧ெ௄் ൅ ߚ௜ூே஽ ܴ௧ூே஽ ൅ ߝ௜௧
where ܴ௜௧ refers to the monthly return of stock i in month t; ܴ௧௅ை஼ is the
monthly return of other firms headquartered in the same Metropolitan
Statistical Area (MSA) as firm i; ܴ௧ெ௄் is the monthly return of the market
preprint
portfolio; and ܴ௧ூே஽ is the monthly industry return (based on 48 Fama-
French industries) corresponding to stock i. All returns are in excess of the
30-day T-bill rates.
NCOMPENF
accepted
Non-competition enforceability index compiled by Garmaise (2011).
manuscript
*
Annual COMPUSTAT data items are provided in parentheses.
38
References:
Anderson, J. D., and J. E. Core. 2012. Measuring managerial incentives to increase firm
volatility provided by debt, stock, and options. Working paper, MIT.
Armstrong, C., and R. Vashishtha. 2012. Manager stock options, differential risk-taking
incentives, and firm value. Journal of Financial Economics 104 (1): 70–88.
Babenko, I., and R. Sen. 2011. Do non-executive employees have information? Evidence from
employee stock purchase plans. Working paper, Arizona State University, and Hong
Kong University of Science and Technology.
Bargeron, L., K. Lehn, and C. Zutter. 2010. Sarbanes-Oxley and corporate risk-taking. Journal of
Accounting and Economics 49: 34–52.
Beatty, A. 1994. An empirical analysis of the corporate control, tax and incentive motivations for
adopting leveraged employee stock ownership plans. Manager and Decision Economics
15 (4): 299–315.
Beatty, A. 1995. The cash flow and informational effects of employee stock ownership plans.
Journal of Financial Economics 38: 211–240.
Beaver, W., P. Kettler, and M. Scholes. 1970. The association between market-determined and
accounting-determined measures of risk. The Accounting Review (October): 654–682.
Benartzi, S. 2001. Excessive extrapolation and the allocation of 401 (k) accounts to company
stock. The Journal of Finance 56: 1747-1764.
preprint
Blasi, J., D. Kruse, and R. Park. 2010. Prevalence, characteristics, and employee views of
financial participation in enterprises. Chapter 1 in Shared Capitalism at Work, edited by
D. Kruse, R. Freeman, J. Blasi, 41–75. University of Chicago Press.
accepted
Bova, F., Y. Dou, and O.-K. Hope. 2013. Employee ownership and firm disclosure.
manuscript
Contemporary Accounting Research (forthcoming).
Browning, M., and A. Lusardi. 1996. Household saving: Micro theories and micro facts. Journal
of Economic Literature 34: 1797–1855.
Carpenter, J. 2000. Does option compensation increase managerial risk appetite? Journal of
Finance 55: 2311–2331.
Cassell, C. A., Huang, S. X., Sanchez, J. M., and M. D. Stuart. 2012. Seeking safety: The
relation between CEO inside debt holdings and the riskiness of firm investment and
financial policies. Journal of Financial Economics 103: 588 – 610.
Chava, S., and A. Purnandam. 2010. CEOs versus CFOs: Incentives and corporate policies.
Chen, C. R., T. L. Steiner, and A. M. Whyte. 2006. Does stock option-based manager
compensation induce risk-taking? An analysis of the banking industry. Journal of
Banking and Finance 30: 915–945.
Cohen, D., A. Dey, and T. Lys. 2013. Corporate governance reform and executive incentives:
Implications for investments and risk taking. Contemporary Accounting Research 30 (4):
1296–1332.
39
Coles, J. L., N. D. Daniel, and L. Naveen. 2006. Manager incentives and risk-taking. Journal of
Financial Economics 79 (2): 431–468.
Core, J., and W. Guay. 1999. The use of equity grants to manage optimal equity incentive levels.
Journal of Accounting and Economics 28: 151–184.
Core, J., and W. Guay. 2001. Stock option plans for non-executive employees. Journal of
Financial Economics 61: 253–287.
Dyreng, S. D., M. Hanlon, and E. L. Maydew. 2008. Long-run corporate tax avoidance. The
Accounting Review 83 (1): 61–82.
Faleye, O., V. Mehrotra, and R. Morck. 2006. When Labor Has a Voice in Corporate
Governance. Journal of Financial and Quantitative Analysis 41: 489-510.
Fama, E. F., and K. R. French. 1997. Industry costs of equity. Journal of Financial Economics
43 (2): 153–193.
FitzRoy, F. R., and K. Kraft. 1986. Profitability and profit-sharing. The Journal of Industrial
Economics 35 (2): 113–130.
Foss, N. 2003. Selective intervention and internal hybrids: Interpreting and learning from the rise
and decline of the Oticon spaghetti organization. Organization Science 14 (3): 331-349.
Frye, M. B. 2004. Equity-based compensation for employees: firm performance and
determinants. Journal of Financial Research 27 (1): 31–54.
Garmaise, M. J. 2011. Ties that truly bind: Noncompetition agreements, manager compensation,
preprint
and firm investment. Journal of Law, Economics, and Organization 27 (2): 376–425.
Greene, W. H. 2003. Econometric Analysis. Prentice Hall, Upper Saddle River, New Jersey.
Guay, W. 1999. The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and
accepted
determinants. Journal of Financial Economics 53: 43–71.
manuscript
Hayes, R. M., Lemmon, M., and M. Qiu. 2012. Stock options and managerial incentives for risk
taking: Evidence from FAS 123R. Journal of Financial Economics 105 (1): 174–190.
Hirshleifer, D., Low, A., and S. H. Teoh. 2012. Are overconfident CEOs better innovators?
Journal of Finance 67 (4): 1457-1498.
Hochberg, Y., and L. Lindsey. 2010. Incentives, targeting, and firm performance: An analysis of
non-manager stock options. Review of Financial Studies 23 (11): 4148–4186.
Kalmi, P., A. Pendleton, and E. Poutsma. 2005 Financial participation and performance in
Europe. Human Resource Management Journal 15 (5): 54-67.
Kedia, S., and S. Rajgopal. 2009. The impact of location on broad based stock option plans.
Klein, A. 2002. Audit committee, board of director characteristics, and earnings management.
Journal of Accounting and Economics 33 (3): 375–400.
Kotter, Jason D. 2013. Technological change, job tasks, and CEO pay. Working paper,
University of Michigan.
Lambert, R., D. Larcker, and R. Verrecchia. 1991. Portfolio considerations in valuing executive
compensation. Journal of Accounting Research. 29 (1): 129–149.
40
Larcker, D.F., and T. O. Rusticus. 2010. On the use of instrumental variables in accounting
research. Journal of Accounting and Economics 49: 186–205.
Lewellen, K. 2006. Financing decisions when managers are risk averse. Journal of Financial
Economics 82: 551–589.
Lusardi, A., D. Schneider, and P. Tufano. 2011. Financially fragile households: Evidence and
implications. Working paper No. w17072, National Bureau of Economic Research.
Low, A. 2009. Manager risk-taking behavior and equity-based compensation. Journal of
Financial Economics 92: 470–490.
May, D. 1995. Do manager motives influence firm risk reduction strategies? Journal of Finance
50: 1291–1308.
Oyer, P. 2004. Why do firms use incentives that have no incentive effects? Journal of Finance
59: 1619–1649.
Oyer, P., and S. Schaefer. 2005. Why do some firms give stock options to all employees? An
empirical examination of alternative theories. Journal of Financial Economics 76: 99–
133.
Petersen, M. A. 2009. Estimating standard errors in finance panel data sets: Comparing
approaches. Review of Financial Studies 22 (1): 435–480. Chicago
Pendleton, A., J. McDonald, and A. Robinson. 1995. The impact of employee share ownership
plans on employee participation and industrial democracy. Human Resource
Management Journal 5 (4): 44-60.
preprint
Pirinsky, C., and Q. Wang. 2006. Does corporate headquarters location matter for stock returns?
Journal of Finance 61: 1991–2015.
accepted
Rajgopal, S., and T. Shevlin. 2002. Empirical evidence on the relation between stock option
compensation and risk taking. Journal of Accounting and Economics 33: 145–171.
manuscript
Roberts, M., and T. Whited. 2012. Endogeneity in empirical corporate finance. Working paper,
University of Pennsylvania, University of Rochester.
Rosenstein, S., and J. Wyatt. 1990. Outside directors, board independence, and shareholder
wealth. Journal of Financial Economics 26: 175–191.
Smith, C., and R. Stulz. 1985. The determinants of firms’ heading policies. Journal of Financial
and Quantitative Analysis 28: 391–405.
Stulz, R., 1984. Optimal hedging policies. Journal of Financial and Quantitative Analysis 19:
127–140.
Tufano, P. 1996. Who manages risk? An empirical examination of risk management practices in
the gold mining industry. Journal of Finance 51: 1097–1137.
41
TABLE 1
Descriptive statistics
Panel A: Univariate statistics

Variable N Mean Stdev Min Q1 Median Q3 Max
SD_∆ROA 17,983 0.051 0.079 0.000 0.009 0.021 0.059 1.039
SD_RET 18,189 0.039 0.029 0.000 0.021 0.031 0.047 1.217
EMPSTK 18,417 0.008 0.023 0.000 0.000 0.000 0.004 0.183
EXESTK 18,417 0.035 0.082 0.000 0.001 0.004 0.022 0.571
EXEOPT 8,702 0.314 0.260 0.000 0.084 0.277 0.500 0.974
MV 18,417 4,190 20,054 0 112 484 1,794 508,329
BM 18,320 0.553 0.624 -3.144 0.230 0.417 0.696 6.098
LEV 18,319 0.214 0.208 0.000 0.024 0.173 0.338 1.062
CF 18,314 0.111 0.249 -1.265 0.049 0.142 0.239 0.627
NOL 18,417 0.401 0.490 0 0 0 1 1
RET 18,216 0.256 1.144 -0.994 -0.246 0.065 0.429 28.10
Panel B: Pearson (Spearman) correlations are above (below) the diagonal

SD_∆ROA SD_RET EMPSTK
preprint
EXESTK EXEOPT Log(MV) BM
SD_∆ROA 1 0.432 -0.121 0.023 0.121 -0.270 -0.043

SD_RET 0.541 1
accepted
-0.123 0.103 0.118 -0.389 0.104
manuscript
EMPSTK -0.244 -0.251 1 -0.062 -0.103 0.101 0.037
EXESTK 0.084 0.185 -0.101 1 -0.009 -0.238 0.041
EXEOPT 0.085 0.075 -0.126 -0.107 1 0.190 -0.182
Log(MV) -0.350 -0.461 0.240 -0.369 0.178 1 -0.346
BM -0.097 -0.010 0.072 0.067 -0.255 -0.332 1
We define all variables in the Appendix. The sample includes 18,417 firm-year observations with non-
missing EMPSTK and EXESTK from 1999 to 2009. Each year, all variables except for MV, SD_RET,
NOL, and RET are Winsorized at 1 and 99 percent. In Panel B, all correlations are significant at the 5
percent level, except for the Pearson correlation between EXESTK and EXEOPT, and the Spearman
correlation between BM and SD_RET.
42
TABLE 2
The relationship between employee stock ownership and corporate risk
Dependent variable: Future corporate risk measures
SD_∆ROA SD_RET R&D CAPEX

1 2 3 4
-0.077*** -0.027*** -0.278*** -0.276***
EMPSTK
(-3.97) (-4.06) (-4.81) (-3.98)
-0.025** 0.008* -0.040 0.057
EXESTK
(-2.18) (1.85) (-0.81) (0.91)
0.023*** 0.010*** 0.090*** 0.059***
EXEOPT
(7.94) (12.60) (7.38) (6.62)
-0.005*** -0.003*** -0.005*** -0.013***
Ln(MV)
(-8.37) (-17.63) (-2.60) (-7.72)
0.005** 0.001* -0.022*** -0.054***
BM
(2.52) (1.73) (-3.02) (-9.94)
0.001 0.002 -0.041* -0.128***
LEV
(0.18) (1.54) (-1.66) (-7.31)
-0.059*** -0.009*** -0.253*** 0.098***
CF
(-6.00) (-5.16) (-6.27) (4.54)
NOL
0.002
(1.43)
preprint
0.001*
(1.83)
0.011*
(1.67)
0.001
(0.26)
0.003*** 0.002*** -0.002 0.029***
RET
(3.57)
accepted
(6.15) (-0.89) (6.69)
Industry FE YES manuscript

YES YES YES
Time FE YES YES YES YES
R2 0.432 0.850 0.562 0.806

*, **, *** Significantly different from zero at the 0.10, 0.05, and 0.01 level, respectively, using a two-tailed test.
We define all variables in the Appendix. All continuous variables except for MV, SD_RET, NOL, and
RET are Winsorized at 1 percent and 99 percent each year. We estimate the regressions using OLS and
allow the errors to cluster by firm. All regressions include industry and year fixed effects (FE), where
industries are defined using the Fama-French (1997) 48-industry classification. We report t-statistics in
parentheses below the estimated coefficients. The sample includes 8,702 firm-year observations with non-
missing variables from 1999 to 2009.
43
TABLE 3
Incorporating the interaction between executive stock and optionholding and the relation
between employee stockholding and risk
Panel A: Linear specification for the interactions with executive stockholding (EXESTK) and
optionholding (EXEOPT)
SD_∆ROA SD_RET
1 2
0.017 0.007
EMPSTK
(0.60) (0.68)
-0.019 0.009**
EXESTK
(-1.57) (2.00)
0.026*** 0.012***
EXEOPT
(8.15) (12.88)
-1.173* -0.280
EMPSTK×EXESTK
(-1.77) (-1.12)
-0.309*** -0.116***
EMPSTK×EXEOPT
(-3.54) (-4.53)
-0.005*** -0.003***
Ln(MV)
preprint
(-8.28)
0.005***
(-17.74)
0.002*
BM
(2.58) (1.79)
accepted (1.67)
0.001 0.002*
LEV
(0.28)
CF manuscript-0.009***
-0.059***
(-6.02) (-5.23)
0.002 0.001*
NOL
(1.39) (1.77)
0.003*** 0.002***
RET
(3.53) (6.16)
Industry FE YES YES

Time FE YES YES
R2 0.433 0.850
44
Panel B: Discrete variable specification for the interaction with executive optionholding
(EXEOPT).
SD_∆ROA SD_RET
1 2
-0.005 -0.015
EMPSTK
(-0.18) (-1.74)
-0.092*** -0.008
EMPSTK×MEDEXEOPT
(-3.31) (-0.80)
-0.160*** -0.035**
EMPSTK× HIGHEXEOPT
(-3.19) (-2.48)
-0.019 0.010**
EXESTK
(-1.50) (2.01)
0.026*** 0.011***
EXEOPT
(8.40) (12.38)
-1.008 -0.187
EMPSTK×EXESTK
(-1.43) (-0.75)
-0.005*** -0.003***
Ln(MV)
(-8.55) (-17.73)
0.005** 0.001*
BM
preprint
(2.26) (1.76)
0.002 0.002
LEV
(0.35) (1.59)
accepted
-0.069*** -0.011***
CF
(-6.33) (-5.35)
NOL manuscript 0.001*

0.002
(1.31) (1.73)
0.003*** 0.002***
RET
(3.21) (5.78)
Industry FE YES YES
Time FE YES YES
R2 0.445 0.851
We define all variables in the Appendix. All continuous variables except for MV, SD_RET, NOL, and
RET are Winsorized at 1 percent and 99 percent each year. In Panel B, each year, we sort firms into three
equally-sized groups based on EXEOPT. MEDEXEOPT is an indicator variable set to 1 for the middle
terciles of EXEOPT and 0 otherwise. HIGHEXEOPT is an indicator variable set to 1 for the highest EXEOPT
tercile and 0 otherwise. We estimate the regressions using OLS and cluster the errors by firm. All
regressions include industry and year fixed effects (FE), where industries are defined using the Fama-
French (1997) 48-industry classification. We report t-statistics in parentheses below the estimated
coefficients. The sample includes 8,702 firm-year observations with non-missing variables from 1999 to
2009.
45
TABLE 4
Using instrumental variables and a two-stage least squares methodology
Panel A: 1st-stage regressions of employee stock ownership on instrumental variables
Intercept CASHETR LOCBETA NCOMPENF Adj. R2
0.009*** 0.024*** 0.002*** -0.001***
EMPSTK 0.022
(11.09) (9.85) (6.78) (-7.42)
Panel B: 2nd-stage regressions of corporate risk on predicted employee stock ownership and controls
SD_∆ROA SD_RET
1 2
-1.761*** -0.588***
P_EMPSTK
(-6.84) (-8.17)
-0.024** 0.004
EXESTK
(-1.97) (1.01)
0.014*** 0.008***
EXEOPT
(4.74) (8.76)
-0.004*** -0.003***
Ln(MV)
(-6.05) (-16.45)
preprint
0.00** 0.004***
BM
(2.21) (3.45)
0.002 0.004**
LEV
(0.31) (2.12)
CF accepted -0.009***
-0.054***
manuscript
(-5.95) (-4.50)
0.000 -0.000
NOL
(0.16) (-0.41)
0.005*** 0.002***
RET
(2.90) (6.07)
Industry FE YES YES

Time FE YES YES
Adj. R2 0.463 0.862
P_EMPSTK is the predicted value obtained from a first-stage regression of EMPSTK on CASHETR,
LOCBETA, and NCOMPENF. We define all other variables in the Appendix. All continuous variables
except for MV, SD_RET, NOL, and RET are Winsorized at 1 percent and 99 percent each year. We
estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include
industry and year fixed effects (FE), where industries are defined using the Fama-French (1997) 48-
industry classification. We report t-statistics in parentheses below the estimated coefficients. The sample
includes 5,211 firm-year observations with non-missing variables from 1999 to 2009.
46
TABLE 5
Including controls for lagged values of the dependent variable
SD_∆ROA SD_RET
1 2
0.252*** 0.539***
Lag(Dep. Var) (10.30) (22.70)
-0.047*** -0.011***
EMPSTK (-2.71) (-2.66)
-0.019* 0.004
EXESTK
(-1.91) (1.52)
0.019*** 0.004***
EXEOPT
(6.72) (6.13)
-0.003*** -0.001***
Ln(MV)
(-6.44) (-9.58)
0.007*** 0.001
BM
(3.21) (0.74)
0.003 0.002**
LEV
(0.65) (1.97)
CF preprint
-0.050***
(-4.40)
-0.005***
(-3.24)
0.001 0.000
NOL
accepted
(0.80)
0.002**
(0.23)
0.001
RET
manuscript
(2.10) (1.12)
Industry FE YES YES

Time FE YES YES
R2 0.477 0.880
We define all variables in the Appendix. Lagged dependent variables are measured as follows. Lagged
SD_∆ROA is the standard deviation of seasonally differenced quarterly return on assets over the prior five
years [t-4, t]. Lagged SD_RET is the standard deviation of daily returns in fiscal year t. All continuous
variables except for MV, SD_RET, NOL, and RET are Winsorized at 1 percent and 99 percent each year.
We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include
industry classification. We report t-statistics in parentheses below the estimated coefficients. The sample
includes 8,637 firm-year observations with non-missing variables from 1999 to 2009.
47
TABLE 6
Variation in the relation between employee stock ownership and corporate risk across
strong and weak corporate governance

SD_∆ROA SD_RET
Partitions based on the fraction of independent board directors
Low High Low High
1 2 3 4
-0.064** -0.041* -0.022*** -0.007
EMPSTK
(-2.50) (-1.89) (-3.18) (-0.71)
0.002 0.003 0.009* 0.020
EXESTK
(0.14) (0.06) (1.91) (1.45)
0.015*** 0.027*** 0.008*** 0.012***
EXEOPT
(4.58) (5.28) (7.98) (7.96)
-0.002** -0.005*** -0.002*** -0.003***
Ln(MV)
(-2.41) (-4.88) (-9.92) (-6.71)
0.010** 0.006 0.001 0.001
BM
(2.43) (1.43) (1.06) (0.26)
0.009 -0.001 0.000 -0.000
LEV
(1.35) (-0.20) (0.15) (-0.14)
CF
-0.010
(-1.36)
preprint
-0.054***
(-4.58)
0.003
(1.14)
-0.012***
(-3.69)
0.002 0.001 0.002*** 0.001
accepted
NOL
(0.87) (0.27) (2.79) (1.22)
manuscript
0.004* 0.008*** 0.003*** 0.002**
RET
(1.78) (2.64) (8.34) (2.03)
Industry FE YES YES YES YES

R2 0.467 0.470 0.899 0.841
Ratio of EMPSTK (High/Low) 0.64 0.32

Corporate governance is measured as the percentage of independent directors on the board. High and Low
refer to subsamples with below- and above-median corporate governance, respectively. We define all
other variables in the Appendix. All continuous variables except for MV, SD_RET, NOL, and RET are
Winsorized at 1 percent and 99 percent each year. We estimate the regressions using OLS and allow the
errors to cluster by firm. All regressions include industry and year fixed effects (FE), where industries are
defined using the Fama-French (1997) 48-industry classification. We report t-statistics in parentheses
below the estimated coefficients. The sample includes 5,135 firm-year observations with non-missing
variables from 1999 to 2009.
48
TABLE 7
Relationship between employee stock ownership and corporate risk using the subsample of
positive EMPSTK
SD_∆ROA SD_RET R&D CAPEX

1 2 3 4
-0.040** -0.015** -0.114** -0.207***
EMPSTK
(-1.97) (-2.42) (-2.39) (-3.32)
-0.052*** 0.006 -0.010 0.111
EXESTK
(-3.86) (0.95) (-0.11) (1.02)
0.014*** 0.008*** 0.084*** 0.046***
EXEOPT
(4.12) (6.79) (3.49) (3.88)
-0.005*** -0.003*** -0.003 -0.007***
Ln(MV)
(-6.78) (-11.45) (-1.16) (-3.75)
0.001 0.002 -0.024** -0.029***
BM
(0.24) (1.30) (-2.28) (-4.36)
0.008 0.002 -0.022 -0.101***
LEV
(1.27) (0.92) (-0.74) (-4.48)
-0.038*** -0.010*** -0.262*** 0.117***
CF
(-3.14)
-0.001
preprint
(-3.83)
0.000 -0.005
(-3.15) (3.69)
-0.003
NOL
(-0.50) (0.71) (-0.48) (-0.46)
RET
0.001
(1.29) accepted
0.001***
-0.001
(2.77)
(-0.40)
0.019***
(3.57)
Industry FE YES
manuscript
YES YES YES
R2 0.442 0.851 0.522 0.824

This table is based on the subsample of 4,204 firm-year observations with positive EMPSTK and non-
missing dependent and other control variables. We define all variables in the Appendix. All continuous
variables except for MV, SD_RET, NOL, and RET are Winsorized at 1 percent and 99 percent each year.
We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include
industry classification. We report t-statistics in parentheses below the estimated coefficients.
49
TABLE 8
Relation between housing price changes and corporate risk

SD_∆ROA SD_RET
1 2 3 4
0.162*** 0.161*** 0.439*** 0.437***
Lag(Dep. Var) (6.41) (6.41) (18.33) (18.33)
0.016 0.041** 0.004 0.012**
∆HPI (1.59) (2.43) (1.21) (2.21)
-0.043** -0.016**
BOOM*∆HPI
(-2.09) (-2.49)
-0.012 -0.012 0.007 0.006
EXESTK
(-0.91) (-0.95) (1.61) (1.59)
0.017*** 0.017*** 0.005*** 0.005***
EXEOPT
(6.12) (6.09) (6.60) (6.59)
-0.004*** -0.004*** -0.002*** -0.002***
Ln(MV)
(-7.12) (-7.13) (-9.51) (-9.63)
0.006*** 0.006*** 0.001 0.001
BM
(2.64) (2.64) (1.23) (1.22)
0.003 0.003 0.002* 0.002*
LEV
(0.55) (0.60) (1.87) (1.93)
CF
-0.055***
(-6.33)
preprint
-0.055***
(-6.31)
-0.007***
(-3.92)
-0.007***
(-3.89)
0.002 0.002 0.000 0.000
NOL
accepted
(1.43) (1.43) (0.59) (0.60)
0.002** 0.002** 0.000 0.000
manuscript
RET
(2.47) (2.45) (0.68) (0.68)
Industry FE YES YES YES YES

R2 0.480 0.481 0.865 0.865
Lagged dependent variables are measured as follows. Lagged SD_∆ROA is the standard deviation of
seasonally differenced quarterly return on assets over the prior five years [t-4, t]. Lagged SD_RET is the
standard deviation of daily returns in fiscal year t. ∆HPI is the annual percentage change in house price
index for the state in which the firm is headquartered (http://www.fhfa.gov/Default.aspx?Page=87).
BOOM is an indicator variable set to 1 for the observations during the housing boom period (2004-2007)
and 0 otherwise. We define all other variables in the Appendix. All continuous variables except for MV,
SD_RET, NOL, and RET are Winsorized at 1 percent and 99 percent each year. We estimate the
regressions using OLS and allow the errors to cluster by firm. All regressions include industry and year
fixed effects (FE), where industries are defined using the Fama-French (1997) 48-industry classification.
We report t-statistics in parentheses below the estimated coefficients. The sample includes 8,702 firm-
year observations with non-missing variables from 1999 to 2009.
50

Non-Executive Employee Ownership and Corporate Risk

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Non-Executive Employee Ownership and Corporate Risk

Uploaded by

Copyright:

Available Formats

The Accounting Review • Issues in Accounting Education • Accounting Horizons

Online Early — Preprint of Accepted Manuscript

JEL classification: G30.

Keywords: Employee ownership, employee compensation, executive compensation, risk

JEL classification: G30.

Keywords: Employee ownership, employee compensation, executive compensation, risk

An extensive literature considers how different forms of compensation create incentives

Our motivation is two-fold. First, we identify eight subgroups of research investigating

agnostic and “let the data speak.”

thus bear both systematic and idiosyncratic risk.

held by non-executive employees, it captures a significant portion of all involuntary holdings.

a percentage of total shares outstanding. preprint

measurement error might negatively bias our estimated coefficient on non-executive

the research design should work against our predictions.2

options, as well as by interactions among these holdings.3

incentives to increase stock volatility.

associated with other regressors or the regression error.

We consider different approaches to address these concerns, both when we seek to

relatively independent approaches which increases the reliability of our inferences.

alert researchers that incentives created by equity-based compensation for non-executive

spur future work that develops a better understanding of causal relationships.

Section V contains robustness checks. Section VI concludes.

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

Executive stock and option holdings and risk: theory

concave relation between utility and wealth,manuscript

capital that is employer-specific.5

depending on the relative strengths of the two opposing incentives.6

remains unhedged at the personal level.7

Evidence on executive stock and option holdings and risk

large stock holdings undertake risk-reducing acquisitions to better diversify assets.

managers to decrease risk.

positive relationship between vega and a firm’s systematic risk.

negative relation between non-executive stockholding and risk might be observed.

Regarding the question of whether non-executive stockholding is large enough to create

(median) stockholding per employee of $10,214 ($3,245). We obtain an alternative estimate by

make employees sensitive to risk.9

of corporate risk managed by executives and non-executives, respectively. Specifically,

executives’ risk-taking behavior.

companies where non-executives have substantial stockholdings. We highlight the comments

input from non-executive employees when contemplating which targets to acquire.

strategic decision-making, but being employee-owned appears to have diminished United’s

executive employee-owners while contemplating an expansion to North Carolina.13 Besides

several employees voicing concerns.

hypotheses, in their alternative forms, as follows:

In concept, employee stockholdings should be measured as a fraction of employee

alternate proxies of EMPSTK in Section V. In particular, as an alternative to scaling EMPSTK by

of the associated t-statistic should not be.

coefficient on EMPSTK toward zero.

belong to a broad range of industries.

Because prior research documents a significant relationship between executive

executive compensation, respectively.

As alternative measures of EXEOPT based on options held by executives, we also

approach should inflate the magnitude of the estimated coefficient on EMPSTK.

option prices, as of six months after the year-end.

average total assets for the quarter.

stockholding and option grants.

<Insert Table 1 approximately here>

analyses designed to test alternative explanations for these results.

Employee ownership and corporate risk

To investigate whether non-executive employee stock ownership is associated with

the following regression model: accepted

ordinary least squares with errors clustered by firm (Petersen 2009).

compensation (EXEOPT). We include six additional variables identified in extant research as