This paper examines the impact of firms’ risk on executives’ decisions to exercise
their executive stock options (ESOs). As the proportion of executives’ remuneration
linked to the value of their firm (and therefore shareholder wealth) has increased, so
the extent to which these executives hold undiversified personal portfolios has also
increased. This lack of personal diversification gives executives a strong incentive to
exercise early. It has been shown that this incentive can be sufficiently strong to
outweigh the beliefs an executive may have regarding the firm’s valuation. I
hypothesise that as the risk of a firm increases, so an ESO exercise is less likely to be
induced by an executive’s private information. Consistent with the need to diversify, I
find that it is only exercises in low risk firms that precede significantly negative
abnormal returns
