CONCLUSIONES Y RECOMENDACIONES

One method to mitigate managerial risk aversion is to design compensation contracts that have a convex payoff structure of the firm's stock price and to give the managers incentives to choose actions that increase firm value and maximize the shareholders’ wealth by increasing the value of their equity invested in the firm (Smith and Stulz, 1985).

Stock option compensation can be useful in motivating risk-averse managers to engage in risky projects preferred by shareholders. In addition to hedging with derivatives, managers can also use derivatives to adopt risky projects. The literature shows that derivatives can be used to hedge market exposure or to speculate on movements in the value of the underlying asset and managers can engage in speculating using derivatives (Stulz, 1996; Hentschel and Kothari, 2001; Adam and Fernando, 2006). Speculating with derivatives generally implies that managers are using derivatives with the primary intention of making a profit or increasing risk (Géczy et al., 2007).

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The convexity in the payoff of stock options encourages managers to reduce derivatives use for risk management.Smith and Stulz (1985) based their arguments on the sensitivity of stock options to stock return volatility. Hedging with derivatives enables managers to diversify risk and to be less exposed to stock price volatility. Smith and Stulz (1985) show that more stock options in an executive’s compensation package can influence their hedging behaviour and provide a disincentive hedging behaviour. The explanation is that stock options create a convex function between the executives’ utility and the firm value. The stock option value has a convex relationship with the underlying stock price and volatility. Thus, the value of managers’ stock options increases with the volatility of the firm’s stock return. This sensitivity to stock return volatility should encourage managers to take more risk. Therefore, providing managers with more stock options in their compensation package will induce appropriate action by managers, reduce risk-related incentive problems, and align the interests of managers and shareholders. In this case managers will benefit from increased firm risk since this will lead to increase volatility of the firm’s value hence the value of their stock options will increase.

Option-based compensation has become an important compensation vehicle for most companies to align the CEO’s interest with shareholders (Duan and Wei, 2009; Rogers, 2002; Coles et al., 2006). Further, it is an effective tool for shareholders to mitigate the effects of excessive risk-aversion by giving managers incentives to adopt rather than avoid risky projects (Hirshleifer and Suh, 1992).

Theoretical literature predicts the existence of a positive relationship between option-based compensation and incentives for managers to increase firm risk because stock price volatility increases managers’ option values. Such models predict a positive association between the stock option compensation and derivatives use for speculation, even if speculation only

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increases the volatility of underlying firm value without a commensurate return to risk (Géczy et al., 2007).

Executive stock options and behavioural responses

Some studies argue that stock option compensation may not always result in a better alignment of interests between managers and shareholders. These studies describe how the behavioural responses of managers, such as discretionary accounting practices and earning smoothing can influence the incentive provided by stock option compensation.

The perspective of agency theory states that compensation contract may sometimes motivate managers to manipulate performance results (Moradi et al., 2015). Prior research in earning management, via discretionary accruals, describes many reasons for manipulating the results of operations, one of which is a bonus plan (Gaver et al., 1995; Bergstresser and Philippon, 2006). This shows that executives’ decisions to smooth earnings can be related to the contractual motive of executive compensation (Healy and Palepu, 2000). Therefore, earnings smoothing can be viewed as an outcome of executives’ opportunistic behaviour to maximize their compensation (Das et al., 2013).

In executive compensation literature, earnings smoothing is defined as under-reporting or over-reporting of earnings via discretionary accruals to manage earnings volatility (Goel and Thakor, 2003; Bouwman, 2014). Thus, earnings smoothing makes reported earnings sometimes higher than economic earnings and sometimes lower.

Prior empirical studies show that managers use their authority to choose accounting methods to achieve their goals (Roychowdhury, 2006; Cohen et al., 2008; Zang, 2012).

Earnings management may occur through the use of discretionary accruals when managers use judgment in financial reporting and in structuring transactions to alter reported results in order to influence the value of their compensation which depend on reported figures (Healy and Wahlen, 1998). For example, Gaver et al. (1995) and Burgstahler and Dichev (1997)

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show that when earnings before discretionary accruals fall below the lower bound, specified by the bonus plan, managers select income increasing discretionary accruals. This indicates that managers manipulate reported earnings for their own gains and their incentives to use earnings smoothing increase when they have a direct stake in the reported numbers. Accordingly, managers may exploit accounting rules to manage their reported earnings with the intent of obtaining some private gain and they view this as a useful tool to dress up financial statements to increase bonuses and job security at the expense of shareholders (Healey and Wahlen, 1999; Roychowdhury, 2006; Cohen et al., 2008; Zang, 2012).

Large stock option compensation may influence managerial behaviour and provide an incentive to manipulate firms reported earnings, in order to increase the value of their stock options (Rajgopal and Shevlin, 2002). Bergstresser and Philippon (2006) and Das et al. (2013) present empirical evidence that earning management via discretionary accruals is more pronounced at firms where the CEO’s total compensation is more closely tied to the value of stock options. They argue that managers with more stock compensation will tend to smooth more, while stock options encourage the manager to increase stock price volatility. This is mainly because higher stock price volatility increases the value of the options. Managers will tend to overstate earnings when the option component is relatively large, and when the sensitivity of the option value to stock price is relatively high (Gao and Shrieves, 2002). Denis, Hanouna and Sarin (2006) find that there is a significant positive association between opportunistic management choices and stock option incentives.

These studies show that providing managers with incentives compensation requires careful consideration of their possible good and ill effects. In this context, earnings management can be viewed as a mechanism that allows managers to avoid the undesirable consequences of risk on the value of their stock options. Such behaviour would make sense for managers whose bonus-linked incentives are focused on meeting explicit targets for earnings.

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2.2.3 CDS use for hedging purposes and CDS use for trading purposes