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Leverage and growth: Effect of stock options

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  • Francis, Bill
  • Hasan, Iftekhar
  • Sharma, Zenu

Abstract

Previous literature documents a negative relationship between leverage and firm growth. This paper finds that once the incentives provided by stock options are accounted for, leverage does not affect firm growth. The paper also finds that the sensitivity of CEOs’ wealth to stock price (i.e. option delta) instead of leverage has a negative relationship with growth. These findings suggest that incentive contracts that tie managers’ wealth to firm value prevent managers from overinvesting. Thus in presence of options the role of debt as a disciplining mechanism has become less important.

Suggested Citation

  • Francis, Bill & Hasan, Iftekhar & Sharma, Zenu, 2011. "Leverage and growth: Effect of stock options," Journal of Economics and Business, Elsevier, vol. 63(6), pages 558-581.
  • Handle: RePEc:eee:jebusi:v:63:y:2011:i:6:p:558-581
    DOI: 10.1016/j.jeconbus.2011.04.003
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    Keywords

    G31; G32; D92; J33; Leverage; Growth; Stock-based compensation;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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