78 Executive Stock Options, Corporate Cash Holdings and M&A Decisions and Petmezas, 2015). As discussed previously, M&A activities may affect both systematic and idiosyncratic risk of firms. While systematic risk may be increased or decreased after M&As, firms can manage or control this risk via hedging activities. However, idiosyncratic risk is more likely increased after M&A deals because it is difficult for acquirers to effectively diversify the exposure to idiosyncratic risk caused by administrative pitfalls. As a result, managers are more concerned with post-merger idiosyncratic risk relative to systematic risk. The greater concern about post-merger idiosyncratic risk would make managers more risk-averse and thus hesitate to conduct the M&A activity. Therefore, a critical way to ensure the risk incentive of ESOs on risk taking is the precautionary cash holdings. The excess cash holdings are useful buffers to hedge against the uncertainty and in turn encourage the managerial risk taking induced by the risk incentive compensation. We therefore make our first prediction. Hypothesis 1: Firms with excess cash holdings (cash-rich firms) are more likely to conduct ESOs-induced M&As than non-cash-rich firms. Chen et al. (2014) find the risk incentive effect of ESOs is positively related to corporate innovative activities, especially to systematic risk because of managerial risk aversion. They also show the risk incentive effect of ESOs decreases after the year 2000 due to the structural changes resulting from the burst of the internet bubble. That is, the risk incentive effect of ESOs is less profound when managers bear higher risk that cannot be diversified and might be derived from an unstable environment. Chen (2008) argues that firms in the new economy, such as computer, software, Internet, telecommunications, or networking industries, tend to hold greater cash assets because they face higher business risk and have more potential valuable investments than those in the old economy. In other words, these new-economy firms have already required excess cash holdings to defend the business risk and support persistent investments. CEOs in new-economy firms who are granted ESOs could not view excess cash holdings as additional buffers against unexpected shocks. Hence, CEOs in old-economy firms are more likely to undertake M&As than those in new-economy firms when both subsamples of new-economy and oldeconomy firms have excess cash holdings. We therefore make our second prediction as follows.
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