These are the questions addressed in this paper. Using a rich data set that enables us to measure both the amount and the precise characteristics of executive stock option holdings, we examine the connection between the risk-taking incentives of stock options and various measures of firm risk. We find that controlling for other effects, CEOs with option holdings that are large relative to their wealth and whose value is sensitive to stock-price volatility tend to increase the volatility of the firms they control. One method for increasing stock volatility which managers employ is to increase firm leverage: We find a positive and significant relation.
