74 Executive Stock Options, Corporate Cash Holdings and M&A Decisions environments. That is, the function of excess cash holdings on ESO-induced idiosyncratic risk taking would be more apparent for firms in the old economy rather than new-economy firms. Covering the Standard and Poor indexed 1500 firms, except financial firms (SIC code 6000-6999) and firms in utility industries (SIC code 4900-4999), we first examine how excess cash holdings affect M&A decisions induced by risk incentive compensation (vega) and find cash-rich firms are more likely to engage in the ESOs-induced M&A activities than non-cash-rich firms. As expected, we further show the positive effect of excess cash on the likelihood of undertaking ESOs-induced M&As is more profound for firms in the old economy. When taking the contracting hypothesis into account, we find the positive effect of excess cash is more apparent in firms with low leverage or low default risk. Our findings identify the critical role of cash holdings in encouraging the risk-taking activities induced by vega compensation, especially for firms originally with low risk exposure (old economy firms) and those with low contracting restrictions (low leverage or default risk firms). Further, given the combination of excess cash and M&A decisions is likely related to the agency problem of overinvestments, what really matters is how the market responds to ESOs-induced risk taking. We thus examine the announcement effect of M&A decisions and find the market does not significantly discount the value of cash-rich firms undertaking ESOs-induced M&As. This finding indicates the market recognizes the M&A decisions induced by ESOs compensation are not necessarily value decreasing to cash-rich firms while investors might still be concerned with the agency problem. When further analyzing future performance, we find similar results that cash-rich firms undertaking ESOs-induced M&As have better future profitability than those not conducting ESOs-induced risk taking, indicating the effect of excess cash on ESOs-induced M&As is more associated with precautionary motives rather than the agency incentive. However, how the market recognizes the future valuation of cash-rich firms conducting ESOs-induced M&As still depends on the firm’s governance environment. We organize this study as follows. The next section discusses the relevant prior literature and develops our hypotheses. Section 3 describes our empirical models, sample collection and measurement of variables. Section 4 presents our empirical results and analyses. In section 5, we draw a conclusion.
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