A distinctive feature of stock options is that they create incentives for managers to take risks. For a sample of 12,071 firm-year alliances over 1992-2003, we find that risk-taking incentives offered by executive stock options (the sensitivity of ESO values to stock return volatility) are statistically associated with greater risk-taking behavior as proxied by one-year ahead alliances. Furthermore, in order to examine the extent to which incentives increase executives’ risk taking, we use two criteria to classify alliances according to the different risk level involved. One is based on the exploration-exploitation framework (March, 1991), and we find that the risk-taking incentives of ESOs encourage managers to undertake more exploitation rather than exploration alliances. The other criterion to classify alliances is according to whether it is a technological or a marketing alliance (Das et al. 1998, 2003). We find that the motivation effect of ESO risk-taking incentives is more significant in technological alliances than in marketing alliances. With regard to the future firm performance after entering into alliances, we find a positive association between ESO risk-taking incentives and subsequent operating performance. When examining different risk level alliances, the positive correlation of ESO risk-taking incentives to firm performance is significantly greater in exploitation rather than in exploration alliances. However, technological and marketing alliances do not exhibit significant differences in the positive correlation of ESO risk-taking incentives to firm performance. Overall, our results are consistent with the idea that ESOs provide executives with incentives to focus on shareholder value-maximizing alliances.

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