| This paper examines the effects of executive stock and stock option ownership on corporate investment efficiency through their impact on investment project riskiness and horizon. Making managerial wealth sensitive to stock price induces managerial risk-avoiding behavior. Hence, higher pay-performance sensitivity (PPS) may not induce managers to choose the best project, since they might prefer projects with more stable cash flows (e.g., less risky or short-term projects). I hypothesize that PPS will increase the riskiness and efficiency of corporate investment projects more when the executive risk-taking incentives from option holdings are bigger.; Empirical evidence from merger and acquisition transactions is consistent with the hypothesis. I find that when the sensitivity of CEO wealth to stock volatility (pay-risk sensitivity, or PRS) is low (high), higher PPS induces managers to make acquisitions of targets with lower (higher) NPV and deal announcement returns. In addition, as PRS increases, higher PPS induces managers to choose more risky targets and targets with more cash flows concentrated in the longer-term. Finally, when PRS is low (high), firm performance, as measured by Tobin's Q and ROA, is not (is positively) related to pay-performance sensitivity. |
