Corporate governance, uncertainty and executive stock option plans

Abstract

The purpose of this paper is to understand the reasons that have led to the use of the stock option plans (SOPs) to reward Spanish CEOs and discuss whether the popularity of this type of incentive can be attributed to the power of the CEO in the Board of Directors. To this end, the study, besides analysing how the level of monitoring and uncertainty influences the use of CEO stock option plans (SOPs) in the 100 firms with the highest stock market capitalisation listed on the Madrid Stock Exchange for the period 1999-2001, it also aims to determine the influence of the level of uncertainty in the design of SOPs. We used both logit models and difference-of-means statistical techniques to analyse the data. The results reveal that 1) the use of SOPs increases as a) the level of monitoring decreases, and b) uncertainty increases; and 2) conventional stock options granted at the money or in the money become more frequent as the uncertainty increases. In light of these results, there is reason to support the approach to the managerial power view and, therefore, to think that in some cases CEOs use SOPs to extract rents from shareholders.Key words: CEO stock options, corporate governance, managerial power (JEL: J33, L21, Ml2, M52)1. IntroductionOver the past decade, the compensation packages of European CEOs have undergone an appreciable change. Stock option plans (SOPs), typical executive compensation systems of English-speaking countries, have rapidly spread throughout Europe. According to the Towers Perrin Consultancy report (2005), between 2001 and 2004, the use of stock options increased by 30% in Italy; 20% in Spain, Japan and Germany; 10% in the Netherlands and 5% in France.As of 2005, the obligation to enter SOPs as expenditure has diminished their use, both in the USA and in Europe. Nevertheless, such changes do not reduce the interest of studying them since SOPs continue to be very popular. In Spain, several studies (Sanchez-Marin & Aragon, 2009; Towers Perrin, 2011) confirm that companies nowadays not only continue to use SOPs to reward their CEOs, but such incentives represent a high proportion of their total compensation.Ironically, this popularity is given when SOPs are criticised by scholars and public opinion because they are costly to shareholders and motivate executives to behave opportunistically (Bebchuk & Fried, 2004; Zhen & Zhou, 2012). Facing the view of the agency theory that considers the SOPs a tool to minimise the agency conflict that exists between CEOs and shareholders, the managerial power theory raises that the executive stock options are mechanisms through which powerful entrenched CEOs extract rent from shareholders without upsetting the public opinion (Bebchuk et al., 2002; Bebchuk & Fried, 2004; Collins et al., 2010).Consequently, based on the approaches of the agency theory and managerial power theory, the aim of this study is to understand the reasons that have led to the use of SOPs as compensation system for Spanish CEOs, and discuss whether their popularity can be attributed to the power of the CEO in the Board of Directors. In order to do so, this study, besides analysing how the monitoring of the Board of Directors and the uncertainty context influence the use the CEO stock option plans (SOPs) in the 100 firms with the highest stock market capitalisation listed on the Madrid Stock Exchange, it also aims to determine the influence of the level of uncertainty in the design of SOPs.Investing this issue in the Spanish context, it is important for the following reasons: First, our study contributes to overcome the shortage of the existing studies in Europe, particularly in Spain. The empirical studies of managerial compensation have almost exclusively focused on the USA context and have used USA data (Fiss, 2006, p. 1013). According to Zattoni (2007), Zattoni & Minichilli (2009), and Festian & Sahkiants (2011), in Europe, there are still very few studies that have analysed the dissemination and characteristics of stock incentives. …