Impact of Risk-Taking on Firm Value

Abstract

This paper investigates the relationship between managerial risk-taking and firm value as measured by Tobin’s Q. We conduct OLS regressions to examine the relationship between firm value and managerial risk-taking. To consider differential behaviors by different levels of risk-taking, we conduct separate tests on different risk-taking levels and on a dummy variable for risk-taking. We also adjust for industry fixed effects and address potential endogeneity issues with a two-stage least square (2SLS) approach. We find that risk-taking is positively related to firm value, and that this relationship is driven mainly by firms with relatively higher levels of risk-taking. We confirm the findings with various sub-periods, with industry fixed effects, and with two-stage linear regressions. Finally, we show that excessive risk-taking is not value-destroying. Subsequent tests report that higher risk-taking manifests as positive but slightly reduced capital allocation efficiency. When managers engage in more risk-taking, they increase the efficiency of capital allocation, suggesting that both immediate payoffs as well as long-term gains contribute to the boost in firm value. While the prior studies examine managerial risk-taking, none of them explicitly investigate its relation to a variable of particular importance to shareholders: firm value measured as Tobin’s Q. Furthermore, prior studies do not examine whether high levels of risk-taking can lead to the acceptance of negative NPV investments and consequently destroy firm value.