Investor Sentiment and Stock Option Vesting Terms

Abstract

Using the details of vesting terms, we document that stock options granted in high sentiment periods tend to have shorter vesting period/duration, and are more likely to vest completely or have a significantly larger fraction vested within one year of the grant date relative to low sentiment periods. Further, we show that the sentiment effect on vesting terms is more pronounced among managers whose newly granted compensation comprises primarily stock options, and less pronounced for firms with strong monitoring mechanisms (i.e., more independent boards and higher institutional ownership). In addition, we explore the cross-sectional variation in sentiment-driven mispricing, and find that greater analyst coverage attenuates the impact of investor sentiment on vesting terms. Finally, we find that firms providing short vesting schedules during high sentiment periods indeed have significantly lower stock returns in the post-vesting period. Taken together, our evidence suggests that managers recognize prevailing sentiment, and demand stock options with short vesting terms to take advantage of mispriced stock prices and reduce the exposure of their wealth to the risk imposed by sentiment-driven mispricing.