Non-Executive Employee Ownership and

THE ACCOUNTING REVIEW American Accounting Association
Vol. 90, No. 1 DOI: 10.2308/accr-50860

2015
pp. 115–145
Non-Executive Employee Ownership and

Corporate Risk
Francesco Bova
University of Toronto
Kalin Kolev
Jacob K. Thomas
X. Frank Zhang
Yale University
ABSTRACT: Prior research documents a negative link between risk and executive holding
of stock, but a corresponding positive link for options. We find a similar negative relation for
non-executive holding of stock. Our finding is consistent with the view that non-executives
not only face significant incentives to reduce risk when they hold stock, but they are also able
to affect corporate risk. While endogeneity cannot be ruled out fully, the results of a battery of
tests suggest that it plays a limited role. A second robust result is that the documented
relation becomes more negative as option-based executive compensation increases.
Overall, corporate risk is related to the incentives created by stock and options held by both
executives and non-executives, as well as interactions among those incentives.
Keywords: employee ownership; employee compensation; executive compensation;
risk.
JEL Classiﬁcations: G30.
I. INTRODUCTION
A
n extensive literature considers how different forms of compensation create incentives for
managers to alter the distribution of stock returns. A subset of that research focuses on
incentives to affect corporate risk, which is defined as the volatility of stock returns in an
We thank Mingming Qiu, Ilona Babenko, and Rik Sen for sharing data, and Joseph Blasi, Robert Bushman, Brian
Cadman, Yiwei Dou, Mary Ellen Carter, John Core, Richard Frankel, Wayne Guay, Rachel Hayes, Gilles Hilary, Doug
Kruse, DJ Nanda, Darius Palia, Robert Verrecchia, Terry Warfield, and seminar participants at the 2012 AAA Annual
Meeting, University of Alberta 2012 Accounting Research Conference, Colorado 2012 Summer Accounting Research
Conference, Concordia University, London Business School, the Louis O. Kelso Fellowship 2012 Mid-Year Meeting,
IAFEP 2012 Conference, INSEAD, University of Maastricht, University of Miami, University of Toronto, and
University of Wisconsin for their valuable feedback. Authors Bova and Thomas are grateful for funding from the Louis
O. Kelso Faculty Fellowship for research in employee ownership and the Yale School of Management, respectively.
Editor’s note: Accepted by John Harry Evans III.
Submitted: December 2012
Accepted: June 2014
Published Online: July 2014
115
116 Bova, Kolev, Thomas, and Zhang
efficient market, by actions that either increase volatility (e.g., invest in risky projects or increase
leverage) or decrease volatility (e.g., hedge exposure to operating risk). Prior research (Stulz 1984;
Smith and Stulz 1985; Guay 1999) predicts a negative relation between stockholding and stock
volatility. The empirical evidence (May 1995) confirms that prediction. However, these findings are
based mainly on compensation paid to senior executives. We investigate whether the negative
relation between stockholding and stock volatility observed in prior research extends to non-
executive employees.
Our motivation is twofold. First, we identify eight subgroups of research investigating equity-
based compensation, represented by the interaction among how holdings of stocks/options create
incentives for executives/non-executives to affect the first/second moment of returns. Of the eight
subgroups, the incentives created by stock held by non-executives to affect the second moment of
returns have received the least attention. Second, the arguments for a negative relation between risk
and stockholding are weaker for non-executives than for executives, because of the lower likelihood
of satisfying two necessary conditions. The first condition is that the fraction of an employee’s
wealth, including human capital in the form of future compensation, that is correlated with
employer stock price has to be large enough to result in significant incentives to reduce risk. The
second condition is that employees have the ability to alter risk, either by eliminating risky
alternatives from consideration or by taking actions subsequently to reduce volatility. We analyze
why these conditions may or may not hold for non-executives. Even though our research
hypotheses are stated as if the conditions hold, we are agnostic and ‘‘let the data speak.’’
Prior research on the relation between corporate risk and managerial stockholding (Stulz 1984;
Smith and Stulz 1985; Guay 1999) suggests that the relation will generally be negative. While
higher stock volatility increases the value of compensation that has a convex relation with stock
price, such convexity becomes relevant for stockholding only when firms are close to financial
distress. We believe that the same arguments apply to non-executive employees. Importantly,
higher stock volatility creates greater disutility for employees holding stock, relative to outside
shareholders. Employees are more risk-averse because their human capital in the form of future
compensation is tied to the firm’s fortunes, and because they are also less able to diversify, they bear
both systematic and idiosyncratic risk.
We use two measures of the dependent variable to reflect the extent to which employees
influence corporate behavior that affects stock volatility. Consistent with our definition of risk, our
first risk measure is the standard deviation of daily stock returns over the 12 months following the
disclosure of non-executive stockholding. To the extent that the market may not be fully efficient,
stock volatility will represent a noisy measure of corporate risk.1 As an alternative and potentially
less noisy proxy, we use the standard deviation of seasonally differenced quarterly accounting
return on assets over the next 20 quarters. Finally, we also consider other indirect measures of
corporate risk, such as the level of R&D expenditures.
Our main independent variable, employee stockholding, is derived from Form 5500 data filed
with the Department of Labor for defined contribution plans invested in employer stock. These data
cover retirement plans for which employees are eligible to receive benefits at or after retirement,
including employee stock ownership plans and 401(k) plans, but exclude non-retirement plans,
such as restricted stock and stock purchase plans (see Frye [2004] for a discussion of this
taxonomy). Thus, while our measure does not encompass all employer stock held by non-executive
employees, it captures a significant portion of all involuntary holdings. Non-voluntary holdings,
which can be sold at any time, should create lower incentives to reduce risk.
1
One alternative is to replace observed stock volatility with volatility implied by put and call option prices. We find
similar results for a subsample with available option data. Section V contains robustness analyses that investigate the
extent to which our results are sensitive to alternative proxies for our variables.
The Accounting Review

January 2015
Non-Executive Employee Ownership and Corporate Risk 117
Recent studies such as Guay (1999) and Coles, Daniel, and Naveen (2006) use the vega of
executive wealth (options plus stock plus human capital) as the explanatory variable, while
controlling for delta. Vega and delta represent the sensitivity of managerial wealth to changes in
return variance and share price, respectively. Because the available data do not allow estimation of
delta and vega for non-executive wealth, we use the level of employee shareholding, stated as a
percentage of total shares outstanding.
We consider a number of control variables, including market capitalization, book-to-market
ratio, leverage, presence of tax loss carryforwards, and effective tax rates. To control for the
incentives of senior executives to influence risk, we include the percentage of total shares held by
those executives and option awards as a percent of total compensation. While our main results do
not include controls for non-executive optionholdings because these data are not available in
Compustat before 2004, we include those controls for the subperiod with available data to confirm
that our inferences are not sensitive to this omission.
Because we cannot control for all relevant effects and the variables we use are likely measured
with error, we consider possible ways in which the omission of controls and measurement error
might negatively bias our estimated coefficient on non-executive stockholding. We conduct
extensive sensitivity analyses and conclude that any bias created by the research design should
work against our predictions.2
We find two robust relations. First, employee stockholding is strongly negatively related to risk
measures that are linked to increases in stock volatility. Second, this relation becomes more
negative as the level of executive optionholding increases. Taken together, our results suggest that
corporate risk is affected by both executive and non-executive stockholdings and options, as well as
by interactions among these holdings.3
With respect to causality, our first result is consistent with the view that higher stockholding for
non-executives significantly increases their incentives to reduce stock volatility, and that these
employees have the ability to take the necessary risk-reducing actions. This latter inference is new to
compensation research in accounting and finance. However, work in labor economics and
organizational behavior suggests that non-executives are directly and indirectly able to influence
corporate behavior, and that this influence increases with employee ownership. In essence, employee
ownership is most effective when combined with increased employee participation, which results in
increased cooperation, delegation, and responsibility sharing (Kalmi, Pendleton, and Poutsma 2005;
Foss 2003; Pendleton, McDonald, and Robinson 1995; Blasi, Kruse, and Park 2010). Further, if
higher executive optionholding creates incentives for executives to increase risk, then our second
result is consistent with the view that the incentives for non-executives to reduce stock volatility are
heightened in cases where executives have greater incentives to increase stock volatility.
Prior research raises significant concerns regarding endogeneity affecting the associations we
document, as well as any causal inferences we draw. We focus on three common sources of endogeneity
(Roberts and Whited 2012): simultaneity, correlated omitted variables, and measurement error. There
are few exogenous variables in our analysis, and many variables are determined jointly.4 Alternative
2
For example, we should consider executive holdings, not annual grants, of options and should deflate stock and
option holdings by total wealth. Without data on senior executive wealth, we considered different combinations of
stock and option holdings and grants in the robustness analyses in Section V, and different scaling variables. The
reported results reflect the two measures with the most significant coefficients on the control variables, to reduce any
potential negative bias associated with the coefficient on our measure of non-executive stockholding.
3
We assume that senior executives within the same firm face similar incentives to affect risk. Some prior research,
however, suggests that there are differences (e.g., between CEOs and CFOs in Chava and Purnanandam [2010]).
4
To the extent that actual compensation deviates from optimal compensation, for idiosyncratic reasons, the
explanatory variables considered in our analyses are more likely to be exogenously determined. These idiosyncratic
reasons include unexpected changes in the factors that determine optimal compensation (Core and Guay 1999) and
managers who override weak boards.

January 2015
explanations of the results include reverse causality and omitted correlated variables. Finally, our
coefficient estimates might be biased because the above-mentioned measurement errors associated with
regressors are related to either measurement error associated with other regressors or the regression error.
We consider different approaches to address these concerns, both when we seek to establish
association and when we infer causal relationships. First, we use an instrumental variables
approach, where we model employee ownership in the first-stage regression. Second, to control for
potential omitted variables, we include lagged values of the dependent variables as an additional
explanatory variable. Surviving this hurdle should substantially increase the robustness of our
findings because it addresses many alternative explanations, including omitted correlated variables
and reverse causality. Finally, we examine cross-sectional variation in the relation between non-
executive stockholding and risk along dimensions that might help us eliminate alternative
explanations for our results. We observe similar results for several relatively independent
approaches, which increases the reliability of our inferences.
We believe we are the first to examine the link between non-executive employees and
corporate risk. Our main contributions are to document the two robust patterns we observe, and to
alert researchers that incentives created by equity-based compensation for non-executive employees
might also play an important role in corporate behavior. Consideration of non-executive employees
may be relevant even for studies focused on senior executives if, as our results suggest, there are
interaction effects between the two sets of incentives. Our results may spur future work that
develops a better understanding of causal relationships.
Section II next discusses prior research and develops our hypotheses. Section III discusses the
data and provides descriptive statistics. Section IV presents the main results, and Section V contains
robustness checks. Section VI concludes.
II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
Executive Stock and Option Holdings and Risk: Theory

Smith and Stulz (1985) and Stulz (1984) identify two opposing incentives in assessing the
impact of stock and option holdings on a manager’s desire to affect risk. The two incentives relate
to the two steps that link managerial utility to stock volatility. The first step connects managerial
utility to volatility in managerial wealth, and the second step connects managerial wealth to stock
volatility. The first incentive, which motivates managers to reduce risk, relates to the first step above
and reflects managerial risk-aversion. Because risk-averse managers exhibit a concave relation
between utility and wealth, volatility in the portion of wealth that is positively related to stock price
results in a risk premium, where the certainty equivalent amount of wealth is discounted relative to
mean or expected values of wealth. The portion of managerial wealth that is positively related to
stock price includes stockholding, optionholding, and any human capital that is employer-specific.5
The second incentive, which causes managers to increase risk, arises when the second relation
between stock volatility and the portion of stock price-sensitive wealth is convex. Such convexity in
the second step operates counter to the first-step concavity created by risk-aversion, and can
dominate the concavity effect if it is sufficiently strong. Convexity in the second step is created by
option-like features of equity-based wealth. Specifically, options that are close to or below the
exercise price and stocks that are close to financial distress when asset values approach levels of
5
Incentives to reduce risk are also created by a different component of managerial wealth referred to as ‘‘inside debt’’
(Anderson and Core 2012; Cassell, Huang, Sanchez, and Stuart 2012), which includes unsecured deferred
compensation. Given the absence of data on inside debt for non-executives, we ignore incentives related to such
claims.

January 2015
debt exhibit convexity in the second step. In contrast, options that are deep-in-the-money and stocks
that are not close to financial distress exhibit little convexity.
Whether stockholding and optionholding create net incentives to increase or decrease risk
depends on the relative magnitudes of the two incentives. Given that the incentives to increase risk
are generally weak for managerial stockholding in firms not in financial distress, the incentives to
reduce risk are expected to dominate. For managerial optionholding, however, the incentive to
increase risk becomes more relevant, and the net effect varies from case to case depending on the
relative strengths of the two opposing incentives.6
Note that total stock volatility, both idiosyncratic and systematic, is relevant here. Managers
can reduce the impact of both types of risk on their holdings by judicious asset allocation when
investing their remaining wealth, or by purchasing collars that eliminate both upside and downside
risk. However, the maintained assumption in the literature is that a substantial portion of the
underlying exposure of managerial wealth to stock price volatility remains unhedged at the personal
level.7
Evidence on Executive Stock and Option Holdings and Risk

Prior evidence supports the predicted negative relation between managerial stockholding and
incentives to take on more risk. For example, Tufano (1996) investigates a sample of publicly
traded gold mines and finds that executives compensated with stock are more likely to hedge gold
price risk. Similarly, the findings in May (1995) suggest that executives with very large stock
holdings undertake risk-reducing acquisitions to better diversify assets.
The evidence on options-based compensation is mixed. While the early evidence suggests that
options generally create incentives to increase risk, more recent evidence suggests that options do
not create net incentives to increase risk. The early evidence includes Rajgopal and Shevlin (2002),
who show that the sensitivity of a CEO’s option-based pay to stock return volatility for a sample of
oil and gas producers is positively linked to the variability of future cash flows from exploration
activities. The more recent evidence includes Hayes, Lemmon, and Qiu (2012), who show that the
substantial reduction in option grants after 2006, when the expensing of options becomes
mandatory under SFAS 123R, is not associated with efforts by managers to decrease risk.
More recent research combines stock and optionholding and estimates the sensitivity of
managerial wealth to stock volatility. Guay (1999) measures the convexity of CEO compensation
by estimating the convexity contributed by a stock option or share of common stock as the change
in the security’s value for a 1 percent change in the annualized standard deviation of stock returns.
Guay (1999) finds that this measure of convexity, vega, is more meaningful for firms with growth
options, reflected by higher investments in R&D and capital expenditures. Coles et al. (2006) and
Low (2009) use the Guay (1999) measure and show that a higher sensitivity leads to riskier policy
choices, more investment in R&D, and increased total, systematic, and idiosyncratic risk. Similarly,
Armstrong and Vashishtha (2012) also document a positive relationship between vega and a firm’s
systematic risk.
6
Lambert, Larcker, and Verrecchia (1991), Carpenter (2000), and Lewellen (2006) illustrate why higher optionholding
might increase managers’ incentives to reduce stock price volatility, especially if the probability of having options
finish in-the-money is sufficiently high.
7
Empirical evidence provides support for this assumption. As an example, Hirshleifer, Low, and Teoh (2012)
document that firms with overconfident CEOs have higher return volatility and these CEOs are likely to continue
holding options past the vesting period.

January 2015
Non-Executive Stock Holdings and Risk

Are the preceding results observed for executive stockholding also likely to be observed for
non-executive stockholding? As discussed earlier, even though stockholding should, in theory,
create incentives for all employees to reduce risk, there are a priori reasons to believe that the same
negative relation might not hold for non-executive employees. Levels of stockholding might be low
relative to non-executive employee wealth, resulting in low incentives to reduce risk. Even if such
incentives are strong, the rights to investment, financing, and operational decisions may be retained
by senior executives, leaving non-executives with limited ability to reduce risk. Although we do not
have strong prior beliefs about the actual incentives of employees to reduce risk and their ability to
do so, we present arguments below for why a negative relation between non-executive stockholding
and risk might be observed.
Regarding the question of whether non-executive stockholding is large enough to create
meaningful incentives to reduce risk, we note that about two-thirds of our sample firms have zero
employee stockholding, based on the Form 5500 data on retirement plans. For the remaining firms
with positive employee stockholding, we report two estimates below for levels of stockholding for
the typical employee. We divide the value of stock held in retirement plans from Form 5500 reports
by the total number of employees from Compustat and obtain a mean (median) stockholding per
employee of $10,214 ($3,245). We obtain an alternative estimate by dividing plan assets by plan
participants for employee stock ownership plans (ESOP) that results in a mean (median) of $82,000
($32,000). The first estimate is likely to be a lower bound for employee stockholdings because
many employees hold company stock outside of retirement plans (e.g., restricted stock plans). The
alternate estimate is likely to be an upper bound for employee stockholdings because plan
participants include retirees. Thus, the average plan assets likely overstate the stock held by active
employees.
We are unable to find reliable savings data for typical employees in our sample against which
to compare the preceding estimates of employee stockholding. However, more general evidence
(Browning and Lusardi 1996; Lusardi, Schneider, and Tufano 2011) suggests that median savings
levels are low.8 While savings levels increase with income, they are negative for the first two
quintiles of income and become high only for the highest quintile of earners. If so, typical savings
levels, particularly wealth held as financial assets, for employees in our sample firms during our
sample period are also probably quite low. We assume that total savings are of the same order of
magnitude as annual pay. Moving from total savings to the portion held as employer stock,
estimates in Blasi et al. (2010) for a sample of firms with positive employee stockholding suggest
that the average value of employer stock held is 65 percent of annual pay. If so, the typical holding
of stock may indeed be large enough, as a proportion of total savings, to make employees sensitive
to risk.9
Turning to the second question of whether non-executive employees are able to alter corporate
risk, we conclude that there is a sufficient basis to believe that corporate risk reflects the preferences
of non-executives. Specifically, we envision two non-mutually exclusive mechanisms through
8
For example, Lusardi et al. (2011) examine households’ financial fragility by looking at their capacity to raise $2,000
in 30 days. Using data from the 2009 TNS Global Economic Crisis survey, they document widespread financial
weakness in the United States because approximately one-quarter of Americans report that they could not raise
$2,000 in the allotted time. The results suggest that for the average American, even a $10,000 investment in company
stock represents a large portion of their overall wealth.
9
Arguments could also be made for why non-executives are likely to be more sensitive to risk, relative to executives.
For example, the human capital of non-executive employees might be tied more closely to firm performance, and
non-executives might diversify less than executives because they are less sophisticated investors and are likely to
have less access to financial advisors.

January 2015
which non-executives may affect corporate risk.10 The first potential mechanism assumes that a
board seeking optimal contracts takes into account the different types of corporate risk managed by
executives and non-executives, respectively. Specifically, executives determine strategic investment
risk, such as selecting which project to invest in, whereas non-executive employees manage
operational risk via careful implementation and execution of executives’ decisions. Thus, consistent
with prior research, the board grants executives an ex ante optimal compensation package where
stock options induce risk-taking in search of higher returns. At the same time, the board grants non-
executive employees stock to mitigate operational risk, suggesting a negative correlation between
employee stockholding and corporate risk. Taken together, the employees’ careful execution of
executive decisions reduces overall corporate risk without sacrificing the mean payoff, leading to a
higher reward-to-risk ratio. Importantly, this structure also implies that as executives take on more
strategic risk, non-executive employees have stronger incentives to mitigate operational risk,
suggesting that the negative association between employee stockholding and corporate risk
increases in executive risk-taking behavior.
The second potential mechanism reflects the idea that non-executive employees can actually
influence the firm’s strategic decisions. Specifically, non-executives may have the capacity to filter
or influence the menu of projects chosen by management. Thus, the seemingly contradictory
incentives induced by executive options and non-executive stock compensation translate into a
decision-making process that mitigates the potential for excessive risk-taking. This mechanism also
suggests that non-executives’ incentives to reduce risk increase with executives’ risk-taking
behavior.
Consistent with both mechanisms, the labor economics and organizational behavior literatures
document evidence that firms often adopt employee ownership plans and increase employee
decision rights jointly. For example, Blasi et al. (2010) assess data from the 2002 and 2006 General
Social Surveys and the 2001 and 2006 National Bureau of Economic Research (NBER) Company
Surveys. That study concludes that employees compensated with company stock are more likely to:
(1) be involved in making decisions on the job and setting department goals; (2) operate with
minimal supervision; (3) have an increased say about what happens on the job; and (4) make
decisions cooperatively.11 Moreover, further evidence suggests that increased stockholding and
optionholding results not only in higher levels of cooperation, but also in more stringent monitoring
of employees by fellow employees (e.g., Fitzroy and Kraft 1986; Hochberg and Lindsey 2010).
To assess whether there is anecdotal support for the notion that non-executives can impact both
operational and strategic risks, we interviewed several executives of publicly traded companies
where non-executives have substantial stockholdings. We highlight the comments from Steven
Fisher, Senior VP and Treasurer of Science Applications International Corporation (SAIC), a
private company that was majority-owned by its employees.12 After SAIC went public (NYSE:
SAI), employees divested most of their holdings. As such, Mr. Fisher has observed variation in
employee ownership over time and is able to comment on the effect of that variation on firm
outcomes. Mr. Fisher feels that an equity stake for employees can impact corporate risk in two
ways.
10
We take no position on which mechanism is likely to dominate, as this is an issue outside the scope of the present
study.
11
The General Social Survey assesses a national area probability sample of non-institutionalized adults. The survey was
conducted by the National Opinion Research Center of The University of Chicago in 2002 and 2006. The NBER
Company survey assesses data from employee surveys across 14 companies and 323 worksites in 2001 and 2006.
12
The transcript of the interview is available from the authors upon request. SAIC is only one of many anecdotal
examples of firms where employees directly affect corporate risk. For example, survey evidence finds that 41 percent
of employees in employee-owned firms feel that they have an influence over the company’s strategic decisions (see:
http://www.ownershipassociates.com/ocr2.shtm).

January 2015
First, equity stakes for non-executive employees increase the level of effort and commitment to
implementing and executing the strategic decisions of executives. For example, SAIC’s employee-
owners worked hard to cross-fertilize cultures and integrate management following the acquisition
of a target firm. By putting in extra effort to implement executives’ strategies, employee-owners at
SAIC not only reduced integration risk, but also reduced the volatility of SAIC’s subsequent
returns. Second, equity stakes for non-executives increased the breadth of participation in the firm’s
strategic decision-making. For example, SAIC solicited input from non-executive employees when
contemplating which targets to acquire.
Similar outcomes have been documented at other firms where non-executives own large stakes
in the company. United Airlines became majority-owned by its employees in the mid-90s when the
firm’s owners gave non-executive employees 55 percent of the firm’s equity. Consistent with our
conjectures, not only did the new employee-owners influence United’s strategic decision-making,
but being employee-owned appears to have diminished United’s appetite for corporate risk. For
example, United Airlines aborted its acquisition of US Air in 1995 specifically because of
employee opposition to the acquisition (Faleye, Mehrotra, and Morck 2006). Similarly, New
Belgium Brewing, a firm majority-owned by its employees and the focus of a recent documentary
on employee ownership, solicited feedback from all of its non-executive employee-owners while
contemplating an expansion to North Carolina.13 Aside from providing non-executives with an
opportunity to inform the firm’s strategic decisions, having an equity stake in the firm apparently
had a significant impact on the employees’ risk-taking preferences. Specifically, employees
appeared cautious about the prospect of expansion, with several employees voicing concerns.
Overall, increased stockholding by non-executive employees can potentially both create
incentives to reduce corporate risk and lead to greater decision rights for non-executives. The
mechanisms discussed above also suggest that non-executive employees have stronger incentives to
mitigate risk when executives are likely to take more risk. Thus, we state our research hypotheses,
in their alternative forms, as follows:
H1: Cross-sectionally, higher levels of non-executive employee stock ownership are related to
lower corporate risk.
H2: The negative correlation between employee stockholding and corporate risk increases in
the executives’ propensity to take on risk.
III. SAMPLE AND DESCRIPTIVE STATISTICS
Sample
To obtain employee stock ownership data, we search the U.S. Department of Labor Form 5500
filings for defined contribution plans that allow direct investment in employer stock. As described
in Bova, Dou, and Hope (2013), we include ‘‘employee stock ownership plans (ESOPs), 401(k)
plans that allow an investment in employer stock as an option, deferred profit sharing plans invested
in employer stock, and employer stock bonus plans.’’ When there are discontinuities in the data
series for a firm, we impute the missing observation for year t as the average of values obtained for
years t1 and tþ1. To merge these data with Compustat, we aggregate stockholdings across plan
sponsors with the same Employee Identification Number (EIN).
13
We the Owners, directed by David Romero and produced by the Foundation for Enterprise Development, 2013,
available at http://wetheowners.com/.

January 2015
In concept, employee stockholdings should be measured as a fraction of employee wealth. In

the absence of data on employee wealth, we scale employee stockholding (EMPSTK) by the
number of shares outstanding, as detailed in Appendix A. While this deflator could cause
considerable measurement error, we believe the error would bias the estimated coefficient on
EMPSTK toward zero if other variables are measured correctly in the regression (Roberts and
Whited 2012). To verify that the choice of deflator does not drive our results, we explore alternate
proxies of EMPSTK in Section V. In particular, as an alternative to scaling EMPSTK by outstanding
shares, we consider the dollar value of stock holdings per employee. The sign and significance
levels for the coefficient on EMPSTK are unchanged when using this alternate proxy.
Bova et al. (2013) describe the fractions of different types of plans, as well as the fraction of
total stock value held by those plan categories included in and excluded from EMPSTK. For
example, 29.7 percent of firms have ESOP plans, while 83.4 percent of firms have non-ESOP plans.
However, ESOP plans account for 71.4 percent of the common stock held across all plans in the
sample, while non-ESOP plans account for 28.6 percent of the common stock held across all
plans.14
While EMPSTK includes employee stock held in various retirement plans, it excludes stock
held in non-retirement plans, such as restricted stock and employee stock purchase plans. For some
firms, such as Apple, the fraction of total employee stockholding excluded from EMPSTK is
substantial. However, the exclusion of some employee stockholdings from EMPSTK does not bias
our findings in favor of H1. If the excluded holdings are unrelated to holdings included in EMPSTK,
then the associated measurement error biases the coefficient on EMPSTK toward zero. Even if the
excluded and included stockholdings are positively related, the magnitude of the negative
coefficient on EMPSTK would be biased upward, but the magnitude of the associated t-statistic
should not be.
We next discuss the implication for our tests of stockholdings that are excluded from
EMPSTK. Omitting stock held voluntarily, as in employee stock purchase plans (ESPPs), is less
of a concern because employees could elect to sell those shares at any time.15 Employee holding
of restricted stock, on the other hand, should create incentives similar to those created by plans
included in EMPSTK that require employees to hold stock. To investigate potential bias in the
estimate of EMPSTK, we examine the correlation between EMPSTK and restricted stock grants
(not holdings) for a 2005 sample obtained from Mingming Qiu at The University of Utah. The
correlation is 0.058, which we view as low. Additional empirical analysis suggests that the
coefficients on EMPSTK are virtually unchanged when we include grants of restricted stock as an
additional variable in the regressions for year 2005. Overall, while EMPSTK likely measures non-
executive stockholding with error, we believe those errors bias the magnitude of the coefficient on
EMPSTK toward zero.
Our sample reveals few obvious patterns of industry clustering based on levels of EMPSTK.
For example, most technology firms have low levels of EMPSTK, where restricted stock is not
included in EMPSTK. Most industries have both firms with zero and with high levels of EMPSTK.
In particular, firms in the top 10 percent of EMPSTK, which include DuPont, Guidant, Exxon,
14
In untabulated analysis, we assess whether having an ESOP or non-ESOP plan affects our inferences. We partition the
sample of firms where EMPSTK . 0 into subsamples for firms with ESOP plans and firms with non-ESOP plans. We
continue to find a negative relationship between EMPSTK and risk-taking in both subsamples.
15
Nevertheless, in untabulated analyses, we include stockholdings held in ESPPs and find that the coefficient on
EMPSTK continues to be negative and significant in all models. We thank Ilona Babenko and Rick Sen for allowing
us to use the ESPP data hand-collected for Babenko and Sen (2011). We do not include ESPP data in our main
EMPSTK variable for the tabulated analysis because fair market values for the stock held in ESPPs are only available
when they are voluntarily disclosed by firms. As a result, there are comparatively few firm-years with data in the
ESPP sample.

January 2015
Abbott Labs, GE, AT&T, Kroger, Southwest Airlines, and Proctor & Gamble, belong to a broad
range of industries.
Even though our focus is on non-executive stockholdings, their optionholdings are also likely
to affect incentives to alter risk and should be controlled for. However, we are unable to obtain
option data for the earlier part of our sample period, as Compustat only provides data for option
variables beginning in 2004. Therefore, while our main results exclude non-executive
optionholdings, we confirm that the negative relation between EMPSTK and the various risk
proxies is robust to including estimates of option grants (EMPOPT) for the subperiod beginning in
2004.
Because prior research documents a significant relationship between executive compensation
and risk, we also control for executive holdings of options and stocks using data from ExecuComp
and Thomson Reuters, respectively. We scale shares held by executives (EXESTK) and options
granted to executives (EXEOPT) by total shares outstanding and total executive compensation,
respectively.
As alternative measures of EXEOPT based on options held by executives, we also considered
the number of options held, scaled by total shares outstanding, and the fair value of options held,
scaled by market value of equity. While optionholdings should be more relevant here than option
grants, we find that the coefficient on EXEOPT is closer to zero for these alternative measures of
EXEOPT. To reduce the likelihood that the magnitude of the coefficient on EMPSTK is overstated
because the impact of EXEOPT is suppressed when we use these alternative measures, we use the
grant-based measure of EXEOPT. We see no reason why this approach should inflate the magnitude
of the estimated coefficient on EMPSTK.
After matching the Form 5500 data with Compustat, our sample contains 60,235
observations for 9,677 individual firms for the period 1999–2009. We next merge the dataset
with Thomson Reuters Insider Filing data to gather information on executive stockholding,
EXESTK, which decreases the sample size to 18,417 observations for 5,371 individual
companies. Our sample size decreases further to 8,702 firm-years when we require information
on executive options, EXEOPT, from ExecuComp, which generally covers only current and past
members of the S&P 1500. We obtain additional financial and market data from Compustat
Annual and CRSP, respectively. Because we use all available observations for each of our tests,
sample size varies across tests depending on the specific variables included. To mitigate the
potential disproportionate influence of outliers, we winsorize all continuous variables, other than
the three market-based variables (MV, SD_RET, and RET), at 1 and 99 percent of each year’s
cross-sectional distributions.
Risk Proxies
The dependent variable should ideally be the portion of expected stock volatility that reflects
employee efforts to reduce risk. The first empirical proxy we use is observed future stock volatility.
We measure stock volatility as the standard deviation of daily stock returns (SD_RET) over the 12-
month period starting from the fifth month after fiscal year-end.16 Because prior research calculates
stock volatility in different ways (Chen, Steiner, and Whyte 2006; Core and Guay 1999), we
conduct robustness tests to confirm that our results are not sensitive to the specific stock volatility
measure used. For example, in Section V, we obtain similar results when we repeat the analyses
using idiosyncratic volatility, measured as the standard deviation of market-model residuals over
16
The five-month lag allows the market to learn about a firm’s financial information. We obtain similar results when
using a four- or six-month lag.

January 2015
the same window, or implied stock volatility based on put and call option prices, as of six months
after the year-end.
Because stock volatility is affected by factors other than employees’ intent to influence stock
market volatility, such as unexpected revisions in discount rates and forecasts of future cash flows,
we consider the volatility of accounting rates of return (e.g., Beaver, Kettler, and Scholes 1970) as
an alternative empirical proxy. The risk measure we construct (SD_DROA) is the standard deviation
of seasonally differenced quarterly accounting return on assets over the subsequent five years,
where return on assets is income before extraordinary items, scaled by average total assets for the
quarter.
Prior literature also uses research and development expense (R&D) and capital expenditure
(CAPEX) as proxies for risk. Whereas the incentive to increase risk is expected to be positively
related to R&D levels, arguments have been made for both positive and negative links with CAPEX.
The evidence confirms the positive relation expected for R&D, but both positive (Guay 1999;
Bargeron, Lehn, and Zutter 2010; Cohen, Dey, and Lys 2013) and negative (e.g., Coles et al. 2006;
Hayes et al. 2012) relations have been observed for CAPEX. The negative relation between non-
executive stock ownership and our two primary risk measures, volatility of stock returns and ROA
changes, are also observed for R&D and CAPEX.
Descriptive Statistics
Table 1, Panel A reports that the average (median) company in our sample has a market
capitalization of $4.2 billion ($484 million), consistent with our requirement for executive
compensation data skewing our sample toward larger companies. Employees hold, on average, 0.8
percent of the employer’s outstanding stock in retirement plans, reflecting the two-thirds of the
firm-years in our sample with zero EMPSTK. Company stock held by the top four executives is, on
average, higher (3.5 percent of shares outstanding) than for the stock held by non-executive
employees (0.8 percent of shares outstanding). For firms with positive EMPSTK, employees and
executives, on average, hold 2.7 and 2.3 percent of shares outstanding, respectively.17 Stock option
grants account, on average, for 31.4 percent of total executive compensation. As with employee
stockholding, there is considerable variation across the sample in both executive stockholding and
option grants.
Turning to the two primary risk measures, the mean (median) values for the standard deviation
of stock returns is 3.9 (3.1) percent, and 5.1 (2.1) percent for the standard deviation of seasonally
differenced quarterly ROA. The remaining columns in Panel A, which describe the distributions for
these two variables, suggest considerable cross-sectional variation.
Table 1, Panel B reports the Pearson and Spearman correlations between pairs of the main
variables of interest. Even though these correlations reflect the effects of other correlated
variables, they provide preliminary evidence on the relation between compensation and
corporate risk. Consistent with the conjecture that corporate risk decreases in non-executive
stock ownership, the Pearson and Spearman correlations between EMPSTK and the two risk
measures are significantly negative. Specifically, the Pearson (Spearman) correlations between
EMPSTK and SD_DROA and SD_RET are 0.121 and 0.123 (0.244 and 0.251),
respectively. Consistent with the results of some prior research (Rajgopal and Shevlin 2002),
the proportion of executive compensation attributable to option grants, EXEOPT, is positively
related to both risk measures. However, the proportion of shares outstanding held by
executives, EXESTK, is also positively correlated with SD_DROA and SD_RET, which is at
17
The result that the average executive stockholding is lower when EMPSTK is positive than for the full sample is
consistent with the negative correlation we observe between EXESTK and EMPSTK in Table 1, Panel B.

January 2015
TABLE 1
Descriptive Statistics
Panel A: Univariate Statistics

Variable n Mean Std. Dev. Min. Q1 Median Q3 Max.
SD_DROA 17,983 0.051 0.079 0.000 0.009 0.021 0.059 1.039
SD_RET 18,189 0.039 0.029 0.000 0.021 0.031 0.047 1.217
EMPSTK 18,417 0.008 0.023 0.000 0.000 0.000 0.004 0.183
EXESTK 18,417 0.035 0.082 0.000 0.001 0.004 0.022 0.571
EXEOPT 8,702 0.314 0.260 0.000 0.084 0.277 0.500 0.974
MV 18,417 4,190.000 20,054.000 0.000 112.000 484.000 1,794.000 508,329.000
BM 18,320 0.553 0.624 3.144 0.230 0.417 0.696 6.098
LEV 18,319 0.214 0.208 0.000 0.024 0.173 0.338 1.062
CF 18,314 0.111 0.249 1.265 0.049 0.142 0.239 0.627
NOL 18,417 0.401 0.490 0.000 0.000 0.000 1.000 1.000
RET 18,216 0.256 1.144 0.994 0.246 0.065 0.429 28.100
Panel B: Pearson (Spearman) Correlations are Above (Below) the Diagonal

SD_DROA SD_RET EMPSTK EXESTK EXEOPT Ln(MV) BM
SD_DROA 1 0.432 0.121 0.023 0.121 0.270 0.043
SD_RET 0.541 1 0.123 0.103 0.118 0.389 0.104
EMPSTK 0.244 0.251 1 0.062 0.103 0.101 0.037
EXESTK 0.084 0.185 0.101 1 0.009 0.238 0.041
EXEOPT 0.085 0.075 0.126 0.107 1 0.190 0.182
Ln(MV) 0.350 0.461 0.240 0.369 0.178 1 0.346
BM 0.097 0.010 0.072 0.067 0.255 0.332 1
The sample includes 18,417 firm-year observations with non-missing EMPSTK and EXESTK from 1999 to 2009. Each
year, all variables except for MV, SD_RET, NOL, and RET are winsorized at 1 and 99 percent. In Panel B, all correlations
are significant at the 5 percent level, except for the Pearson correlation between EXESTK and EXEOPT, and the
Spearman correlation between BM and SD_RET.
We define all variables in Appendix A.
odds with the negative relation predicted by theory and documented in prior evidence (Tufano
1996; May 1995).
IV. RESULTS
We present our main results in this section, and in Section V, we explore a variety of analyses
designed to test alternative explanations for these results.
Employee Ownership and Corporate Risk

To investigate whether non-executive employee stock ownership is associated with reduced
risk, we test for the conjectured negative relation predicted by H1 between future risk measures
(RISKtþ1) and our measure of non-executive stockholding for year t (EMPSTK), using the following
regression model:

January 2015
RISKtþ1 ¼ b0 þ b1 EMPSTK þ b2 EXESTK þ b3 EXEOPT þ b4 LnðMVÞ þ b5 BM þ b6 CF

þ b7 NOL þ b8 RET þ Industry Fixed Effects þ Year Fixed Effects þ e:
ð1Þ
RISK represents the two primary measures of corporate risk, SD_DROA and SD_RET, as well as the
two additional measures we consider, R&D and CAPEX.18 We estimate the models using ordinary
least squares with errors clustered by firm (Petersen 2009).
Our main control variables are executive stock ownership (EXESTK) and option-based
compensation (EXEOPT). We include six additional variables identified in extant research as
important controls in analyzing the relationship between risk and compensation (Tufano 1996; Core
and Guay 1999; Chen et al. 2006; Coles et al. 2006). Specifically, we include the log of market
value of equity (MV) at the end of year t to control for potential economies of scale and the cost of
external financing.19 To account for growth and investment opportunities, we include the book-to-
market ratio (BM) for equity at the end of year t. We also consider leverage (LEV) and free cash
flows (CF) as measures of financial distress and capital availability, respectively.20 We define LEV
as the three-year average of short-term and long-term debt, and CF as cash flow from operations
minus cash flow from investing and cash dividends (Core and Guay 2001). Both variables are
scaled by total assets and three-year averages are computed over years t2 through t. To control for
the impact of the employer’s tax rate on compensation, we include an indicator variable set to 1 if
the company has a positive net operating loss carryforward (NOL) in year t, 0 otherwise. Last, we
control for the company’s stock return (RET) over year t. In untabulated analysis, we further control
for past-ten-year stock returns (Benartzi 2001) and find our results are virtually unchanged.
To control for industry-specific and macro-economic factors, we include industry and year
fixed effects, where the industry classification is based on Fama and French (1997).21 The industry
fixed effects act as additional controls, as the association between non-executive employee
ownership and corporate risk may vary across industries. For example, certain industries require
higher levels of non-transferrable, firm-specific human capital, while other industries are
characterized by firms where employees perform non-routine tasks (Kotter 2013) that may lead
them to have more opportunity to affect corporate risk.22
Table 2 presents coefficient estimates for Model (1). Consistent with H1, EMPSTK exhibits a
significant (at the 1 percent level) negative association with all four future risk measures. These
relationships are economically significant, as well. Based on the Model (1) results reported in
18
We consider both R&D and CAPEX in our primary regression model (Tables 2 and 7), but exclude them from
subsequent analyses. However, we confirm that the results hold for both variables in the additional analyses in Tables
3–5.
19
Because the market value of equity may not fully control for firm size, in untabulated analysis, we use sales (Ln(S))
and the number of employees (Ln(EMP)) as additional control variables. In addition, to address potential non-linear
effects related to size, we include the square of Ln(MV), Ln(S), and Ln(EMP) in the regression. The coefficients on
EMPSTK remain significantly negative after including the additional size and non-linearity controls.
20
We consider alternative proxies for financial distress and capital availability. For example, to capture cash flow
availability, we use interest burden, defined as the three-year average of interest expense scaled by operating income
before depreciation. We also consider alternative measures of financial flexibility, including cash payout, excess cash,
and the cash flow measure including cash used for repurchase, where cash payout is defined as cash dividend plus
cash used for stock repurchases scaled by total assets, and excess cash is defined as cash and its equivalents minus
debt scaled by total assets. The main results remain qualitatively similar.
21
In untabulated analysis, we examine the effect of defining the industry fixed effects at the two-, three-, and four-digit
SIC levels. The coefficient on EMPSTK continues to be negative and significant for each risk measure.
22
This conjecture would be supported if the negative relation between RISKtþ1 and EMPSTK were to become stronger
when industry fixed effects are dropped from Equation (1). In untabulated analyses, we find that the coefficients on
EMPSTK are indeed more negative in the absence of industry fixed effects. We also find that manufacturing and
technology firms tend to have more negative coefficients on EMPSTK than agriculture, financial, and service firms.

January 2015
TABLE 2
The Relationship between Employee Stock Ownership and Corporate Risk
Dependent Variable: Future Corporate Risk Measures
SD_DROA SD_RET R&D CAPEX
1 2 3 4
EMPSTK 0.077*** 0.027*** 0.278*** 0.276***
(3.97) (4.06) (4.81) (3.98)
EXESTK 0.025** 0.008* 0.040 0.057
(2.18) (1.85) (0.81) (0.91)
EXEOPT 0.023*** 0.010*** 0.090*** 0.059***
(7.94) (12.60) (7.38) (6.62)
Ln(MV) 0.005*** 0.003*** 0.005*** 0.013***
(8.37) (17.63) (2.60) (7.72)
BM 0.005** 0.001* 0.022*** 0.054***
(2.52) (1.73) (3.02) (9.94)
LEV 0.001 0.002 0.041* 0.128***
(0.18) (1.54) (1.66) (7.31)
CF 0.059*** 0.009*** 0.253*** 0.098***
(6.00) (5.16) (6.27) (4.54)
NOL 0.002 0.001* 0.011* 0.001
(1.43) (1.83) (1.67) (0.26)
RET 0.003*** 0.002*** 0.002 0.029***
(3.57) (6.15) (0.89) (6.69)
Industry FE Yes Yes Yes Yes
Time FE Yes Yes Yes Yes
R2 0.432 0.850 0.562 0.806
*, **, *** Indicate significantly different from zero at the 0.10, 0.05, and 0.01 levels, respectively, using a two-tailed test.
All continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent and 99 percent each year.
We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include industry and year
fixed effects (FE), where industries are defined using the Fama and French (1997) 48-industry classification. We report t-
statistics in parentheses below the estimated coefficients. The sample includes 8,702 firm-year observations with non-
missing variables from 1999 to 2009.
column 1 of Table 2, the coefficient estimates imply that a one standard deviation increase in
EMPSTK in the current period is associated with a (0.077 0.023)/0.051 ¼ 3.47 percent decrease in
SD_DROA during the next five years, expressed as a percent of mean levels of SD_DROA. Similar
calculations based on the results reported in column 2 imply that a one standard deviation increase
in EMPSTK decreases SD_RET, the volatility in the company’s stock return in year tþ1, by (0.027
0.023)/0.039 ¼ 1.59 percent of the mean levels of SD_RET.
Turning to the control variables, the coefficients on stock option grants for executives
(EXEOPT) are all significantly positive, suggesting that increased option grants for executives
are associated with higher corporate risk, ceteris paribus. The evidence regarding executive
stockholding is mixed, however. The coefficient on EXESTK is negative and significant for
SD_DROA, positive and marginally significant for SD_RET, and insignificant for the remaining
two risk measures. Untabulated analysis shows that if we exclude EXEOPT from the
regressions, the coefficients on EXESTK are either significantly negative or statistically
insignificant.

January 2015
We confirm that the negative relation between EMPSTK and our two primary risk measures is
monotonic and not driven by a few observations with extreme values of EMPSTK. Specifically, in
untabulated analyses, we compare the mean levels of the two risk measures for low, medium, and
high terciles, based on the distribution of EMPSTK each year, and note that the differences in risk
between the low and medium subgroups equal those between the medium and high.23 We also repeat
the analysis reported in columns 1 and 2 of Table 2 after replacing EMPSTK with indicator variables
that allow us to capture the mean risk for the three terciles, after controlling for year and firm fixed
effects. Again, the results suggest that mean levels of risk increase monotonically in EMPSTK.
The Interaction between Non-Executive and Executive Incentives

Our analysis so far assumes that the effects of stockholding for non-executive employees and
stock and optionholding for executives are independent. We consider next the possibility that the
relation between risk and EMPSTK varies with the level of EXEOPT, as posited by H2. Specifically,
the discussion in Section II suggests that the relation between risk and EMPSTK is stronger for higher
levels of EXEOPT. If the executive and non-executive compensation packages are set optimally to
induce more cooperation and a better system of checks and balances, then as executives take more
risk, non-executive employees have stronger incentives to limit those risks, which suggests a negative
coefficient on EMPSTK EXEOPT. For completeness, we also include the interaction between
EMPSTK and EXESTK, although we do not have an ex ante expectation for the sign of this
coefficient. The regression model we use to test H2 adds these two interactions to Equation (1):
RISKtþ1 ¼ b0 þ b1 EMPSTK þ b2 EXESTK þ b3 EXEOPT þ b4 EMPSTKEXESTK
þ b5 EMPSTK EXEOPT þ b6 LnðMVÞ þ b7 BM þ b8 CF þ b9 NOL þ b10 RET
þ Industry Fixed Effects þ Year Fixed Effects þ e: ð2Þ
The main inference from the regression results in Table 3, Panel A is that the coefficient on b5, the
EMPSTK EXEOPT interaction, is negative and significant (at the 1 percent level) for both risk
measures. As conjectured, the relation between non-executive employee stockholding and risk
becomes increasingly negative as the level of options granted to senior executives increases. The
estimate of 0.309 for b5 in column 1 implies that a one standard deviation increase in EXEOPT is
associated with an increase in the reduction of risk attributable to employee stockholding of 0.0803
(¼0.309 0.260). That reduction in risk is more negative than the 0.077 reported in column 1 of
Table 2, which represents the average reduction in SD_DROA associated with increases in employee
stockholding across all levels of EXEOPT. Similar calculations for SD_RET from column 2 suggest
that the corresponding economic magnitude is 0.030 (¼ 0.116 0.260). This value is more
negative than the 0.027 reported in column 2 of Table 2, which represents the average reduction in
SD_RET associated with increases in employee stockholding across all levels of EXEOPT.
The coefficient on the EMPSTK EXESTK interaction, b4, is also negative, but generally
insignificant. Notably, while allowing for interaction effects with executive compensation causes
the coefficient on EMPSTK to decline substantially from Table 2 to Table 3, the coefficients on both
EXESTK and EXEOPT remain relatively unchanged. Although increases in the level of executive
optionholding increase the negative relation between employee stockholding and risk, changes in
levels of employee stockholding have no effect on the impact of executive optionholding and
stockholding on risk.
To provide a more intuitive interpretation of the interaction between non-executive stockholding
and executive optionholding, Table 3, Panel B reports the results of estimating the relation between
23
We create terciles by including all firm-years with a value for EMPSTK equal to 0 in the first tercile. We then divide
all firm-years with strictly positive values for EMPSTK equally between the second and third terciles.

January 2015
TABLE 3
Incorporating the Interaction between Executive Stock and Optionholding and the Relation
between Employee Stockholding and Risk
Panel A: Linear Specification for the Interactions with Executive Stockholding (EXESTK)
and Optionholding (EXEOPT)
SD_DROA SD_RET
1 2
EMPSTK 0.017 0.007
(0.60) (0.68)
EXESTK 0.019 0.009**
(1.57) (2.00)
EXEOPT 0.026*** 0.012***
(8.15) (12.88)
EMPSTK 3 EXESTK 1.173* 0.280
(1.77) (1.12)
EMPSTK 3 EXEOPT 0.309*** 0.116***
(3.54) (4.53)
Ln(MV) 0.005*** 0.003***
(8.28) (17.74)
BM 0.005*** 0.002*
(2.58) (1.79)
LEV 0.001 0.002*
(0.28) (1.67)
CF 0.059*** 0.009***
(6.02) (5.23)
NOL 0.002 0.001*
(1.39) (1.77)
RET 0.003*** 0.002***
(3.53) (6.16)
Industry FE Yes Yes
Time FE Yes Yes
R2 0.433 0.850
Panel B: Discrete Variable Specification for the Interaction with Executive Optionholding
(EXEOPT)
SD_DROA SD_RET
1 2
EMPSTK 0.005 0.015
(0.18) (1.74)
EMPSTK 3 MEDEXEOPT 0.092*** 0.008
(3.31) (0.80)
EMPSTK 3 HIGHEXEOPT 0.160*** 0.035**
(3.19) (2.48)
(continued on next page)

January 2015
TABLE 3 (continued)
SD_DROA SD_RET
1 2
EXESTK 0.019 0.010**
(1.50) (2.01)
EXEOPT 0.026*** 0.011***
(8.40) (12.38)
EMPSTK 3 EXESTK 1.008 0.187
(1.43) (0.75)
Ln(MV) 0.005*** 0.003***
(8.55) (17.73)
BM 0.005** 0.001*
(2.26) (1.76)
LEV 0.002 0.002
(0.35) (1.59)
CF 0.069*** 0.011***
(6.33) (5.35)
NOL 0.002 0.001*
(1.31) (1.73)
RET 0.003*** 0.002***
(3.21) (5.78)
Industry FE Yes Yes
Time FE Yes Yes
R2 0.445 0.851
All continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent and 99 percent each year. In
Panel B, each year, we sort firms into three equally sized groups based on EXEOPT. MEDEXEOPT is an indicator variable
set to 1 for the middle terciles of EXEOPT, and 0 otherwise. HIGHEXEOPT is an indicator variable set to 1 for the highest
EXEOPT tercile, and 0 otherwise. We estimate the regressions using OLS and cluster the errors by firm. All regressions
include industry and year fixed effects (FE), where industries are defined using the Fama and French (1997) 48-industry
classification. We report t-statistics in parentheses below the estimated coefficients. The sample includes 8,702 firm-year
observations with non-missing variables from 1999 to 2009.
risk and EMPSTK for low, medium, and high levels of EXEOPT. The two indicator variables,
MEDEXEOPT and HIGHEXEOPT, are set to 1 for the middle and highest terciles of EXEOPT,
respectively, based on the distribution of EXEOPT each year. The negative coefficients on the
interaction between EMPSTK and MEDEXEOPT (EMPSTK and HIGHEXEOPT) describe the extent to
which the coefficient on EMPSTK becomes more negative as the level of EXEOPT moves from the
bottom tercile to the middle (highest) tercile. Turning to the regression results, the relation between
risk and EMPSTK becomes more negative and the associated statistical significance increases for the
low/high EXEOPT comparison, relative to the low/medium comparison, for both risk measures.24
These results confirm the robustness of the interaction effect documented in Panel A.
24
The differences in coefficients between EMPSTK HIGHEXEOPT and EMPSTK MEDEXEOPT are marginally
significant, with each value having p-values just below 10 percent for the SD_DROA and SD_RET regressions,
respectively.

January 2015
The empirical evidence presented in Tables 2 and 3 is consistent with the predictions of H1 and
H2 that higher levels of non-executive employee ownership of stock increase the incentives for
those employees to take actions that reduce corporate risk, and these risk-reducing incentives
increase further when optionholdings of executives are higher. The latter result is also consistent
with the notion that non-executive stockholdings lead to reduced risk primarily in those settings
where executives are incentivized to take on more risk.
V. ADDITIONAL ANALYSIS AND ROBUSTNESS CHECKS

We acknowledge that the models we estimate so far rely on a number of assumptions that
may not hold. For example, we assume that the level of non-executive stockholding is
exogenously determined. Further, we do not consider reverse causality, where the level of stock
volatility is exogenous and determines levels of stock granted to non-executive employees.
Similarly, we cannot rule out the possibility that omitted variables determine both the level of
non-executive stockholding and stock volatility. For example, firms with more loyal employees
and longer tenure could have higher employee stock ownership and more stable performance. We
next consider a variety of analyses that investigate these alternative explanations.25 After
presenting our results, we review the extent to which the different alternative explanations are
supported or rejected.
The Instrumental Variables Approach

To relax the assumption that EMPSTK is determined exogenously, we rerun the analysis in a
Two-Stage Least Squares (2SLS) framework. Specifically, we search for instrumental variables that
are related to EMPSTK in the first stage and then use the predicted value of EMPSTK in the second
stage, where we estimate the model of risk measures described by Equation (1). Successful
implementation of the 2SLS estimator depends critically on the identification of instrumental
variables correlated with EMPSTK, but not correlated with the error term in the second-stage model
(Greene 2003).
Theory suggests that firms grant employees stock for tax and employee retention
considerations. In particular, the effective tax rate has been shown to be an important driver for
the adoption of employee stock ownership plans (Beatty 1994, 1995). Following Dyreng, Hanlon,
and Maydew (2008), we use the five-year cash outlay for tax, scaled by pre-tax income excluding
special items (CASHETR).
To incorporate employee retention, we consider two region-specific factors: the firm’s
‘‘local beta’’ (LOCBETA) and enforceability of non-competition agreements (NCOMPENF).
The use of LOCBETA is motivated by arguments that a company’s stock price is correlated
with the employees’ outside opportunities. Thus, as equity compensation serves as an
employee-retention tool, the propensity to use an employee stock ownership plan to
compensate employees might be related to the comovement of the employer’s share price
with that of competing employers in the area (Kedia and Rajgopal 2009; Oyer 2004; Oyer and
Schaefer 2005; Pirinsky and Wang 2006). NCOMPENF reflects the idea that non-competition
agreements limit the employees’ job mobility, effectively serving as a retention device.
Following Kedia and Rajgopal (2009), we measure NCOMPENF as the non-competition
25
In this section, we consider multiple approaches to address the potential endogeneity of EMPSTK, which is our main
variable of interest. While EXESTK and EXEOPT are also likely to be endogenous, these variables enter our analyses
only as controls; hence, we do not attempt to model them. To the extent that the same underlying factor determines
EMPSTK, EXESTK, and EXEOPT, the inclusion of EXESTK and EXEOPT as controls in the regression models helps
to address the potential endogeneity of EMPSTK.

January 2015
enforceability index in Garmaise (2011). Our maintained assumption is that these tax and
employee retention consideration proxies do not directly affect corporate risk other than
through the employee channel.26
The first stage of the 2SLS model takes the form:
EMPSTK ¼ h0 þ h1 CASHETR þ h2 LOCBETA þ h3 NCOMPENF þ e: ð3Þ
Using estimated coefficients from Equation (3), we calculate P_EMPSTK, which is the predicted
value of EMPSTK, and substitute it in Equation (1) to get the following second-stage model:
RISKtþ1 ¼ b0 þ b1 P EMPSTK þ b2 EXESTK þ b3 EXEOPT þ b4 LnðMVÞ þ b5 BM þ b6 CF
þ b7 NOL þ b8 RET þ Industry Fixed Effects þ Year Fixed Effects þ e:
ð4Þ
We report results for the first and second stages of the 2SLS analysis in Panels A and B,
respectively, of Table 4. All three instruments in Panel A are significantly related to EMPSTK.
Specifically, firms with higher levels of stockholding for their non-executive employees are
associated with higher effective tax rates and higher comovement of stock prices with those of
local competitors, and are domiciled in states where non-competition agreements are less likely to
be enforced. The F-value from the first stage regression is 63.68, which is higher than the
benchmark of 12.83 with three instrumental variables, suggesting that the model does not suffer
from a weak-instrument problem (Larcker and Rusticus 2010). Results for the second stage,
reported in Panel B, are qualitatively similar to the OLS results reported in Table 2: consistent
with H1, the level of non-executive stock ownership is significantly negatively associated with
both risk measures.27
Controlling for Lagged Dependent Variables

Another technique used to address endogeneity issues, especially omitted correlated
variables and reverse causality, is to include the lagged value of the dependent variable as an
additional control. The underlying logic of this methodology is that the lagged dependent
variable absorbs the effects of omitted correlated variables and reverse causality, provided they
remain relatively stable. We note that this approach biases against finding support for H1,
because the lagged dependent variable suppresses the contribution of EMPSTK, if it is also
relatively stable over time. Overall, observing significant coefficients on EMPSTK in the
presence of controls for lagged values of the dependent variable increases considerably the
likelihood that our main result is due to the factors underlying H1, rather than the many
alternative explanations we consider, especially those based on omitted correlated variables or
reverse causality.
In Table 5, we present the regression for Equation (1) after including the lagged value of
RISK as an additional control. Lagged SD_ROA is computed over the prior five years, t4 to t,
whereas lagged SD_RET is computed for year t. As expected, the coefficients on the lagged
dependent variable are positive and have large t-statistics. The deviation of those coefficient
estimates from one is likely due to underlying mean reversion in the risk measures. More relevant
26
CASHETR may not be a good instrumental variable if it directly affects corporate risk via channels other than
employee stock ownership. In untabulated analysis, we exclude CASHETR from the first-stage regression and find
qualitatively similar results. F-value is 32.74, which is larger than the benchmark of 11.59, suggesting that LOCBETA
and NCOMPENF do not impose a weak-instrument problem (Larcker and Rusticus 2010).
27
P_EMPSTK has a mean of 0.012 and standard deviation of 0.005.

January 2015
TABLE 4
Using Instrumental Variables and a Two-Stage Least Squares Methodology
Panel A: First-Stage Regressions of Employee Stock Ownership on Instrumental Variables

Intercept CASHETR LOCBETA NCOMPENF Adj. R2
EMPSTK 0.009*** 0.024*** 0.002*** 0.001*** 0.022
(11.09) (9.85) (6.78) (7.42)
Panel B: Second-Stage Regressions of Corporate Risk on Predicted Employee Stock

Ownership and Controls
SD_DROA SD_RET
1 2
P_EMPSTK 1.761*** 0.588***
(6.84) (8.17)
EXESTK 0.024** 0.004
(1.97) (1.01)
EXEOPT 0.014*** 0.008***
(4.74) (8.76)
Ln(MV) 0.004*** 0.003***
(6.05) (16.45)
BM 0.00** 0.004***
(2.21) (3.45)
LEV 0.002 0.004**
(0.31) (2.12)
CF 0.054*** 0.009***
(5.95) (4.50)
NOL 0.000 0.000
(0.16) (0.41)
RET 0.005*** 0.002***
(2.90) (6.07)
Industry FE Yes Yes
Time FE Yes Yes
Adj. R2 0.463 0.862
P_EMPSTK is the predicted value obtained from a first-stage regression of EMPSTK on CASHETR, LOCBETA, and
NCOMPENF. All continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent and 99
percent each year. We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include
industry and year fixed effects (FE), where industries are defined using the Fama and French (1997) 48-industry
We define all other variables in Appendix A.
to H1, the coefficient on EMPSTK remains negative and significant (at the 1 percent level) in both
specifications. Thus, even though including lagged risk measures, which reflect the effects of
lagged values of both included and excluded regressors, reduces the estimated coefficients on
EMPSTK (relative to those reported in columns 1 and 2 of Table 2), the remaining effect is

January 2015
TABLE 5
Including Controls for Lagged Values of the Dependent Variable
SD_DROA SD_RET
1 2
Lag(Dep. Var.) 0.252*** 0.539***
(10.30) (22.70)
EMPSTK 0.047*** 0.011***
(2.71) (2.66)
EXESTK 0.019* 0.004
(1.91) (1.52)
EXEOPT 0.019*** 0.004***
(6.72) (6.13)
Ln(MV) 0.003*** 0.001***
(6.44) (9.58)
BM 0.007*** 0.001
(3.21) (0.74)
LEV 0.003 0.002**
(0.65) (1.97)
CF 0.050*** 0.005***
(4.40) (3.24)
NOL 0.001 0.000
(0.80) (0.23)
RET 0.002** 0.001
(2.10) (1.12)
Industry FE Yes Yes
Time FE Yes Yes
R2 0.477 0.880
Lagged dependent variables are measured as follows. Lagged SD_DROA is the standard deviation of seasonally
differenced quarterly return on assets over the prior five years [t4, t]. Lagged SD_RET is the standard deviation of daily
returns in fiscal year t. All continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent and
99 percent each year. We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions
statistically and economically significant. Also, we continue to observe significant positive

coefficients on EXEOPT across both risk measures.
Cross-Sectional Variation in the Impact of Non-Executive Employee Ownership

Another approach we consider to address endogeneity concerns is to investigate cross-sectional
variation in the estimated coefficient on EMPSTK, b1 from Equation (1), in settings where b1
should vary predictably. In Table 3, we already document that b1 becomes more negative with
increases in the level of option-based compensation paid to executives. We consider next the extent
to which b1 varies with the fraction of independent directors, a proxy used in prior research for the
quality of governance (e.g., Klein 2002; Rosenstein and Wyatt 1990). Specifically, we conjecture

January 2015
that strong boards, with more independent directors, provide an alternative mechanism to protect
non-executive stakeholders.28 We also conjecture (and confirm below for our sample) that
compensation for such executives is likely to be tilted more toward options, relative to stock-based
compensation. As a result, the incentives for non-executive employees to reduce risk as their
stockholding increases (captured by the coefficient b1) should be even greater for firms with weak
boards.
We partition our sample at the median level of independent directors each year, and assume
that firms above (below) the median, labeled as high (low) corporate governance partitions, are
associated with strong (weak) corporate governance. We first check whether firms with strong
governance have lower mean and median levels of option-based compensation for senior
executives. Consistent with our conjecture, the mean value of EXEOPT for the strong (weak)
governance partition is 34.01 (36.35) percent of total compensation for senior executives, and the
corresponding median value is 31.43 (34.34) percent. The results on cross-sectional variation in the
coefficient on EMPSTK (Table 6) are consistent with H1: the estimate of b1 is substantially more
negative for firms with fewer independent directors, relative to that for the high governance
partition, for both risk measures.
In a second cross-sectional analysis we test whether the relation between EMPSTK and risk
varies with the degree of employee sophistication. The intuition underlying this analysis is that
‘‘Google engineers’’ should have greater ability to affect corporate risk than ‘‘Home Depot sales
associates.’’ We use SG&A per employee as a proxy for wage per employee, relying on the
premise that ‘‘Google engineers’’ have higher wages than ‘‘Home Depot sales associates.’’
Although SG&A includes items other than wages, we believe that SG&A per employee is a
reasonable proxy for the level of employee wages and sophistication. We define an indicator
variable, SGAdummy, which takes a value of 1 if SG&A per employee is above the sample
median value, and 0 otherwise. Finally, we interact SGAdummy with EMPSTK in Equation (1).
Estimated coefficients on the EMPSTK SGAdummy interaction term are 0.135 and 0.021
(which are significant at the 1 and 20 percent levels) for the SD_DROA and SD_RET regressions,
respectively. These results suggest that the negative correlation between EMPSTK and risk
increases with employee sophistication.
Robustness Analysis
We consider a number of analyses to determine whether our results are robust to alternative
ways of measuring our dependent and independent variables, as well as alternative regression
specifications.29 The results of some of those analyses are summarized below.
Our main independent variable, EMPSTK, is measured as employee stockholding, scaled by
the number of shares outstanding. As an alternative specification motivated by the analysis in Bova
et al. (2013), we consider the logarithm of 1 plus the dollar value of employer stock held per
28
It is also possible that employees seek greater risk reduction when senior executives ignore weak boards, because the
behavior of senior executives is less predictable.
29
As another robustness check, we examine if the EMPSTK effect changes post the Sarbanes-Oxley (SOX) legislation.
If firms generally lower their risk in response to SOX, then there is lower incentive for employees to reduce risk,
suggesting the relationship between EMPSTK and corporate risk should diminish in the post-SOX period. We find
partial support for this argument. Specifically, the coefficient on the interaction term between SOX and EMPSTK is
significantly positive in the SD_RET regression and statistically insignificant in the other three models. In another
robustness check, we control for institutional ownership and find that our inferences remain unchanged. Compared
with the results in Table 2, the coefficients on EMPSTK are slightly stronger in the SD_DROA and SD_RET
regressions, and largely unchanged in the R&D and CAPEX regressions after controlling for institutional ownership.

January 2015
TABLE 6
Variation in the Relation between Employee Stock Ownership and Corporate Risk across
Strong and Weak Corporate Governance
SD_DROA SD_RET
Partitions Based on the Fraction of Independent Board Directors
Low High Low High
1 2 3 4
EMPSTK 0.064** 0.041* 0.022*** 0.007
(2.50) (1.89) (3.18) (0.71)
EXESTK 0.002 0.003 0.009* 0.020
(0.14) (0.06) (1.91) (1.45)
EXEOPT 0.015*** 0.027*** 0.008*** 0.012***
(4.58) (5.28) (7.98) (7.96)
Ln(MV) 0.002** 0.005*** 0.002*** 0.003***
(2.41) (4.88) (9.92) (6.71)
BM 0.010** 0.006 0.001 0.001
(2.43) (1.43) (1.06) (0.26)
LEV 0.009 0.001 0.000 0.000
(1.35) (0.20) (0.15) (0.14)
CF 0.010 0.054*** 0.003 0.012***
(1.36) (4.58) (1.14) (3.69)
NOL 0.002 0.001 0.002*** 0.001
(0.87) (0.27) (2.79) (1.22)
RET 0.004* 0.008*** 0.003*** 0.002**
(1.78) (2.64) (8.34) (2.03)
R2 0.467 0.470 0.899 0.841
Ratio of EMPSTK (High/Low) 0.64 0.32
Corporate governance is measured as the percentage of independent directors on the board. High and Low refer to
subsamples with below- and above-median corporate governance, respectively. All continuous variables except for MV,
SD_RET, NOL, and RET are winsorized at 1 percent and 99 percent each year. We estimate the regressions using OLS
and allow the errors to cluster by firm. All regressions include industry and year fixed effects (FE), where industries are
defined using the Fama and French (1997) 48-industry classification. We report t-statistics in parentheses below the
estimated coefficients. The sample includes 5,135 firm-year observations with non-missing variables from 1999 to 2009.
employee. Untabulated results show that our findings continue to hold with this alternative
specification. For example, focusing on the SD_DROA implementation of Equation (1), the
coefficient on EMPSTK is 0.700 (p-value less than 1 percent), which is comparable to the estimate
of 0.077 (p-value less than 1 percent) reported in column 1 of Table 2, based on the original
measure of EMPSTK.30
30
Whereas the magnitudes of the coefficients are not comparable, as the variables are defined differently, comparison of
the t-statistics and p-values is meaningful.

January 2015
For EXEOPT, we also consider total options held by senior executives, scaled by outstanding
shares, and the dollar value of total options held, scaled by market value of equity. Whereas
theory calls for optionholdings rather than option grants, our results suggest that the alternative
variables based on optionholdings are associated with greater measurement error. We find that the
magnitude and significance of the coefficients on EXEOPT in Table 2 and Table 3 decline when
we use these alternative measures of EXEOPT. We interpret this decline as suggesting that the
greater measurement error associated with these alternative measures biases the otherwise strong
positive relation between risk and EXEOPT toward zero.31 Consistent with our view that
increased error weakens our ability to capture the effect of executive optionholdings, we observe
a stronger effect for non-executive employee stockholdings, reflected in higher magnitude and
significance of the coefficients on EMPSTK. It is possible that the greater measurement error we
observe for alternative measures of EXEOPT is due to a mismatched scaling variable. Theory
calls for optionholdings to be scaled by total executive wealth, which is not easy to estimate.
Therefore, our robustness analyses should not be interpreted as suggesting that option grants are
preferable to optionholdings in compensation research. Our results suggest instead that for the
scaling variables available to us, option grants appear to measure the underlying variable of
interest with lower error.
We also consider alternative measures for our dependent variable that are based on expected,
rather than observed, stock volatility. In particular, we estimate the average implied volatility from
put and call options on contracts with the same strike price. We use data as of six months after the
fiscal year-end and limit our sample to contracts with a six-month expiration and the smallest
amount of in-the- and out-of-the-moneyness. When we replicate the analyses in Table 2 and Table
3, we find estimated coefficients similar to those observed for SD_RET.
In addition to considering the impact of measurement error associated with our variables, we
also conduct other analyses designed to confirm the robustness of our two main results. For
example, we separately examine the subsample of observations with positive employee ownership
to address the concern that our main results are unduly influenced by the large fraction of our
sample with zero employee ownership. Table 7 presents the results from estimating Equation (1) on
the subsample of 4,204 firm-years with positive EMPSTK. Similar to our Table 2 results, we find
that the coefficients on EMPSTK are significantly negative across all four risk measures.32
To investigate the robustness of our finding that non-executive employees have the ability to
influence stock volatility, we consider a case where we expect non-executive employees to take
actions to alter risk in response to exogenous shocks. Specifically, we consider shocks to housing
prices. Assuming that non-executive employees are risk-averse, on average, the intuition underlying
H1 predicts that a decrease in housing prices increases the incentives for non-executive employees
to reduce risk because of an increase in the fraction of total wealth that is positively correlated with
stock prices. Symmetrically, we expect the opposite effect when housing prices increase. One
reason for the increase in the fraction of stock-price-sensitive employee wealth is that a decline in
home values increases the relative fraction of total wealth held in equity-based compensation.
Another reason is our conjecture that employees become less mobile after housing price declines,
31
It is possible that option grants, which are typically at-the-money, better reflect convexity in the relation between
employee wealth and stock price volatility, relative to option holdings, which may include substantial amounts of
options that are deep-in-the-money.
32
We also examine whether the relationship between EMPSTK and our risk-taking proxies are non-linear by including a
squared EMPSTK term in the model. We find very limited evidence of non-linearities (the square term loads with a
weak positive coefficient for only two of the risk-taking proxies—SD_DROA and R&D). We also note that while the
relationship between EMPSTK and both SD_DROA and R&D is convex, this convexity never results in a positive
relationship between EMPSTK and SD_DROA.

January 2015
TABLE 7
Relationship between Employee Stock Ownership and Corporate Risk Using the Subsample
of Positive EMPSTK
SD_DROA SD_RET R&D CAPEX
1 2 3 4
EMPSTK 0.040** 0.015** 0.114** 0.207***
(1.97) (2.42) (2.39) (3.32)
EXESTK 0.052*** 0.006 0.010 0.111
(3.86) (0.95) (0.11) (1.02)
EXEOPT 0.014*** 0.008*** 0.084*** 0.046***
(4.12) (6.79) (3.49) (3.88)
Ln(MV) 0.005*** 0.003*** 0.003 0.007***
(6.78) (11.45) (1.16) (3.75)
BM 0.001 0.002 0.024** 0.029***
(0.24) (1.30) (2.28) (4.36)
LEV 0.008 0.002 0.022 0.101***
(1.27) (0.92) (0.74) (4.48)
CF 0.038*** 0.010*** 0.262*** 0.117***
(3.14) (3.83) (3.15) (3.69)
NOL 0.001 0.000 0.005 0.003
(0.50) (0.71) (0.48) (0.46)
RET 0.001 0.001*** 0.001 0.019***
(1.29) (2.77) (0.40) (3.57)
R2 0.442 0.851 0.522 0.824
This table is based on the subsample of 4,204 firm-year observations with positive EMPSTK and non-missing dependent
and other control variables. All continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent
and 99 percent each year. We estimate the regressions using OLS and allow the errors to cluster by firm. All regressions
classification. We report t-statistics in parentheses below the estimated coefficients.
which then increases the positive correlation between human capital and the employer’s stock price,
thereby increasing the sensitivity of total employee wealth to stock price volatility.
To study the impact of housing price changes, we replace EMPSTK in Equation (1) with
changes in the residential housing price index (DHPI). We measure changes in housing prices by
computing the annual percentage change in the residential house price index for the state where the
firm is headquartered. To capture the impact of changes in housing prices, the dependent variable
should reflect changes in the incentives to reduce risk, and models of risk changes should include
changes in all the independent variables in Equation (1). As some of our variables are measured
over extended periods that will overlap when we take first differences, we include the lagged value
of risk measures as an additional regressor, rather than transforming Equation (1) to replace levels
with first differences. Specifically, we estimate the following model:

January 2015
TABLE 8
Relation between Housing Price Changes and Corporate Risk
SD_DROA SD_RET
1 2 3 4
Lag(Dep. Var.) 0.162*** 0.161*** 0.439*** 0.437***
(6.41) (6.41) (18.33) (18.33)
DHPI 0.016 0.041** 0.004 0.012**
(1.59) (2.43) (1.21) (2.21)
BOOM DHPI 0.043** 0.016**
(2.09) (2.49)
EXESTK 0.012 0.012 0.007 0.006
(0.91) (0.95) (1.61) (1.59)
EXEOPT 0.017*** 0.017*** 0.005*** 0.005***
(6.12) (6.09) (6.60) (6.59)
Ln(MV) 0.004*** 0.004*** 0.002*** 0.002***
(7.12) (7.13) (9.51) (9.63)
BM 0.006*** 0.006*** 0.001 0.001
(2.64) (2.64) (1.23) (1.22)
LEV 0.003 0.003 0.002* 0.002*
(0.55) (0.60) (1.87) (1.93)
CF 0.055*** 0.055*** 0.007*** 0.007***
(6.33) (6.31) (3.92) (3.89)
NOL 0.002 0.002 0.000 0.000
(1.43) (1.43) (0.59) (0.60)
RET 0.002** 0.002** 0.000 0.000
(2.47) (2.45) (0.68) (0.68)
R2 0.480 0.481 0.865 0.865
Lagged dependent variables are measured as follows. Lagged SD_DROA is the standard deviation of seasonally
differenced quarterly return on assets over the prior five years [t4, t]. Lagged SD_RET is the standard deviation of daily
returns in fiscal year t. DHPI is the annual percentage change in house price index for the state in which the firm is
headquartered (see: http://www.fhfa.gov/DataTools/Downloads/Pages/House-Price-Index-Datasets.aspx#mpo). BOOM
is an indicator variable set to 1 for the observations during the housing boom period (2004–2007), and 0 otherwise. All
continuous variables except for MV, SD_RET, NOL, and RET are winsorized at 1 percent and 99 percent each year. We
estimate the regressions using OLS and allow the errors to cluster by firm. All regressions include industry and year fixed
effects (FE), where industries are defined using the Fama and French (1997) 48-industry classification. We report t-
statistics in parentheses below the estimated coefficients. The sample includes 8,702 firm-year observations with non-
missing variables from 1999 to 2009.
RISKtþ1 ¼ b0 þ b1 RISKt þ b2 DHPI þ b3 EXESTK þ b4 EXEOPT þ b5 LnðMVÞ þ b6 BM

þ b7 CF þ b8 NOL þ b9 RET þ Industry Fixed Effects þ Year Fixed Effects þ e:
ð5Þ
We report the regression results in Table 8. The coefficient on DHPI in columns 1 and 3 is

January 2015
positive, but insignificant, for both risk measures, providing only weak support for H1. We next
investigate whether the relation between changes in risk and housing price changes varies over time
depending on the level of housing prices. Specifically, we repeat the analysis allowing for a
different relationship during the housing boom period: 2004–2007. Our motivation for this test is to
incorporate the possibility that employee risk-aversion is lower during the housing boom, as
evidenced by lower down payments and riskier mortgages.33 If the conjectured relationship holds,
then we expect the coefficient on housing price changes to imply a smaller impact on the employee
incentives to reduce risk during the boom period. To test this relationship, we modify Equation (5)
to include an interactive variable (¼ DHPI BOOM), where BOOM is an indicator variable that is
set to 1 for years 2004 through 2007. The results in columns 2 and 4 suggest that the coefficients on
DHPI are close to zero during the 2004–2007 housing boom period (indicated by the sum of the
coefficients on DHPI and DHPI BOOM), but significantly positive during the remaining years of
the sample period. We view these results as supportive of H1.34
To summarize, the analyses described in Section V, which represent our best efforts to
investigate the three sources of endogeneity described in Roberts and Whited (2012)—omitted
variables, simultaneity, and measurement error—do not reveal reasons to invalidate our conclusions
relating to H1. Although such concerns cannot be eliminated fully, we believe that the portfolio of
tests we present reduces the likelihood that our results are spurious, as any validity threats should
have surfaced somewhere in the large number of supporting analyses we conduct.
Simultaneity, and reverse causality in particular, are important concerns for us. We believe,
however, that finding significant results when we include lagged values of the dependent variable as
an additional regressor allays much of those concerns. If stock volatility determined levels of
employee stockholding, then why would employee stockholding continue to explain future stock
volatility even after controlling for contemporaneous stock volatility? Also, it seems unlikely that
reverse causality from stock volatility to employee stockholding would explain the results for
volatility of accounting rates of return, the other primary dependent variable we consider. Similarly,
we believe that our Two-Stage Least Squares implementation offers independent supporting
evidence that simultaneity is less likely to be the driving force here.
VI. CONCLUSION
This study investigates the relation between stock held by non-executive employees and
corporate risk. Prior research finds this relation to be negative for senior executives, which is
consistent with risk-averse executives attempting to reduce the volatility of the portion of their
wealth that is related to stock prices. We investigate whether a similar negative relation is observed
for non-executive employees, based on the assumptions that these employees also have incentives
to decrease risk when stockholding increases, as well as the ability to take actions that reduce
corporate risk.
Consistent with that hypothesis, we find that the greater the amount of company stock owned
by non-executive employees, the lower the firm’s subsequent risk. Probing further, we find that this
relationship is more pronounced when senior executives are compensated more with option-based
33
The desire to avoid risk could decline for a number of reasons during this period, as housing prices increased steadily.
For example, employees might underestimate subjective probabilities of downside scenarios. It is also possible that
corporate risk was deemed less important, as the relative fraction of employee wealth related to housing (employer
stock price) increased (declined).
34
In untabulated analysis, we include EMPSTK and the interaction between EMPSTK and BOOM in the regression. We
find that the coefficient on EMPSTK BOOM is positive and marginally significant in the SD_RET specification and
insignificant in the SD_DROA one, partially supporting the idea that employees mitigate risk less when times are
good.

January 2015
pay, which appears to increase the incentives for managers to take on risk. Finally, we find that
these two results survive a battery of careful attempts to control for potential endogeneity. A
limitation of our results is in order. While we propose several alternative mechanisms that may
drive the relationship between EMPSTK and corporate risk, we are unable to conclusively identify
which mechanism dominates. Thus, identifying the dominant mechanism through which employee
ownership affects corporate risk represents a path for future research.
The collective evidence suggests that the risk preferences of non-executive employees have an
impact on subsequent corporate risk. As with most studies in this literature, endogeneity cannot be
completely ruled out. Thus, inferences from our evidence about the validity of our explanation
should be viewed as a platform for future analysis. Our main contribution is in documenting two
robust associations that are new to the literature. First, we find a strong negative relation between
non-executive stockholding and corporate risk. Second, we find a consistent interaction between
that negative relation and the level of executive optionholding. This latter interaction provides some
of the first evidence that non-executive stockholding may mitigate risk-taking in those
environments where executives are incentivized to take on greater risk.
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APPENDIX A
Variable Definitions
Variable Descriptiona
EMPSTK Employee stock ownership as a percentage of shares outstanding in year t. Data are
obtained from Form 5500 filings for defined contribution (retirement) plans invested in
employer stock. Includes employee stock ownership plans, 401(k) plans, deferred profit-
sharing plans, and employer stock bonus plans. Excludes non-retirement plans, such as
restricted stock plans and employee purchase plans.
EMPOPT The fair value of options outstanding, estimated using the Black-Scholes model and
Compustat data, minus fair values of options held by executives (from ExecuComp),
scaled by the market value of equity.
EXESTK Stock ownership of senior executives, as a percentage of the shares outstanding in year t,
where stock ownership includes both the direct and indirect shares held by the top four
managers (Chairman of the Board, Chief Executive Officer, Chief Financial Officer, and
President). Data obtained from Thomson Reuters Insider Filing.
EXEOPT The value of option awards as a percentage of total compensation (TDC1) from the
ExecuComp annual compensation table in year t, where both option awards and total
compensation are summed across all executives covered by ExecuComp. Most firms report
the top five executives, although ExecuComp collects data for up to nine executives for
some firm-years.
(continued on next page)

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APPENDIX A (continued)
Variable Descriptiona
SD_DROA The standard deviation of seasonally differenced quarterly return on assets over the next
five years (tþ1 to tþ5), where return on assets is measured as income before extraordinary
items (IBQ) scaled by average total assets ((ATQt þ ATQ t1)/2).
SD_RET The standard deviation of daily stock returns for the 12-month period starting from the
fifth month after fiscal year-end.
R&D Annual research and development expense (XRD) scaled by sales (SALE) in year tþ1.
CAPEX Annual capital expenditure (CAPX) scaled by net property, plant, and equipment in year tþ1.
MV The market value of equity (CSHO PRCC_F) at the end of year t.
BM The book-to-market ratio (CEQ /(CSHO PRCC_F )) at the end of year t.

LEV Leverage, measured as the three-year average of short-term and long-term debts, scaled by
total assets ((DLCt þ DLTTt )/ATt ) from year t2 through t.
NOL Net operating loss, measured as an indicator variable equal to 1 if the firm has positive net
operating loss carryforwards (TLCF) in year t.
CF Cash flow, measured as the three-year average of cash flow from operations minus cash
flow from investing and cash dividends, scaled by total assets ((OANCFt IVNCFt
DVt)/ATt) from year t2 through t.
RET Return on the firm’s stock in fiscal year t.
CASHETR The long-run cash effective tax rate, computed as the sum of income tax paid (TXPDt),
divided by the sum of a firm’s pre-tax income (PIt), less special items (SPIt) over the
previous five years.
LOCBETA The local beta bLOC is estimated using the following time-series regression over 1999-2007
for each firm:
Rit ¼ }i þbiLOC RtLOC þ biMKT RtMKT þ biIND RtIND þ eit ;
where Rit refers to the monthly return of stock i in month t; RtLOC is the monthly return of
other firms headquartered in the same Metropolitan Statistical Area (MSA) as firm i; RtMKT
is the monthly return of the market portfolio; and RtIND is the monthly industry return
(based on 48 Fama and French [1997] industries) corresponding to stock i. All returns are
in excess of the 30-day T-bill rates.
NCOMPENF Non-competition enforceability index compiled by Garmaise (2011).
a
Annual Compustat data items are provided in parentheses.

January 2015
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THE ACCOUNTING REVIEW American Accounting Association

Vol. 90, No. 1 DOI: 10.2308/accr-50860

Non-Executive Employee Ownership and

JEL Classiﬁcations: G30.

The Accounting Review

The Accounting Review

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

Executive Stock and Option Holdings and Risk: Theory

The Accounting Review

Evidence on Executive Stock and Option Holdings and Risk

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Non-Executive Stock Holdings and Risk

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III. SAMPLE AND DESCRIPTIVE STATISTICS

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In concept, employee stockholdings should be measured as a fraction of employee wealth. In

The Accounting Review

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Panel A: Univariate Statistics

Panel B: Pearson (Spearman) Correlations are Above (Below) the Diagonal

Employee Ownership and Corporate Risk

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RISKtþ1 ¼ b0 þ b1 EMPSTK þ b2 EXESTK þ b3 EXEOPT þ b4 LnðMVÞ þ b5 BM þ b6 CF

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The Interaction between Non-Executive and Executive Incentives

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(continued on next page)

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V. ADDITIONAL ANALYSIS AND ROBUSTNESS CHECKS

The Instrumental Variables Approach

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Controlling for Lagged Dependent Variables

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Panel A: First-Stage Regressions of Employee Stock Ownership on Instrumental Variables

Panel B: Second-Stage Regressions of Corporate Risk on Predicted Employee Stock

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statistically and economically significant. Also, we continue to observe significant positive

Cross-Sectional Variation in the Impact of Non-Executive Employee Ownership

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RISKtþ1 ¼ b0 þ b1 RISKt þ b2 DHPI þ b3 EXESTK þ b4 EXEOPT þ b5 LnðMVÞ þ b6 BM

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BM The book-to-market ratio (CEQ /(CSHO PRCC_F )) at the end of year t.

The Accounting Review

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