73 NTU Management Review Vol. 31 No. 1 Apr. 2021 Although Liu and Mauer (2011) find the effect of vega on the value of cash is not present in financially constrained firms, the relation between ESOs incentives and cash holdings in their paper remains indistinct because they do not directly analyze how cash assets and ESO compensation affect corporate risk-taking activities. When we simultaneously examining both of the risk-taking and cash holdings, the corporate cash assets do not necessarily benefit debtholders by providing higher liquidity but the precautionary support for the long-term value creation. This study thus examines whether excess cash holdings encourage idiosyncratic risk-taking induced by risk incentive compensation (vega) via analyses of merger and acquisition (M&A) activities. Rather than extending the study of Liu and Mauer (2011), this study comprehensively examines the theories of ESO incentives, corporate cash holdings, and corporate risk-taking. By doing so, we contribute to the literatures of ESOs, cash holdings, and corporate M&As. M&As are one type of important corporate activities reflecting the risk taking induced by ESOs. Although prior studies document M&A decisions affect acquiring firms’ exposure to both systematic risk and idiosyncratic risk (Lintner, 1965; Sharpe, 1964; Lubatkin and O’Neill, 1987; Chatterjee and Lubatkin, 1990; Chen and Steiner, 2000), we choose to use the M&A activity as the proxy of idiosyncratic risk taking based on two reasons. First, while the prior literature suggests post-merger systematic risk could be increased or decreased, the idiosyncratic risk after the deal is more likely to increase. This is because the post-merger idiosyncratic risk is highly associated with the merger integration complexity and the possible misconducting of the merger process, which are common post-merger problems and critical challenges impacting post-merger outcomes (Sherman, 2006). Second, managers are more able to hedge for the increase in systematic risk but less likely to dilute or to hedge the post-merger idiosyncratic risk (Furfine and Rosen, 2011; Armstrong and Vashishtha, 2012). In this case, managers may be more concerned with idiosyncratic risk relative to systematic risk, even though the M&A deal is associated with both kinds of risk. As a result, we believe it is appropriate to use M&As as the proxy for the ESO-induced idiosyncratic risk taking. Since corporate cash assets play an active role in protecting firms from unexpected shocks, we therefore expect managers in firms with excess cash holdings will be more willing to undertake ESOs-induced M&A decisions. Meanwhile, given the concern that the risk incentive of ESOs is not as effective for firms operating in risky environments (new economy) as for firms in low risk environments (old economy) (Chen, 2008), we then expect such a positive effect would be more profound for firms in originally lower risk
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