Stock Option Schedules and Managerial Opportunism

Abstract

This study investigates some of the most important avenues that mangers use to manipulate the value of stock option grants. It also compares the use of these avenues in firms that issue scheduled options and in firms that issue irregular options. We document that before Sarbanes-Oxley Act (SOX), cumulative abnormal returns were significantly negative in the 30-day window before an option grant, but cumulative abnormal returns turned significantly positive after the option grant. This pattern is more pronounced for irregular options, and the evidence supports that opportunistic manipulation of strike prices by CEOs maximized the value of the option grants. We find the disclosure requirement of option grants included in SOX successfully curtails opportunistic behavior in firms that issue scheduled options, but it is less stopping opportunistic behavior in firms that issue irregular options. Firms granting irregular options take larger negative discretionary accruals in advance of the grant than firms that grant scheduled options, and the degree of downward earnings management increases with the size of the subsequent grant. We further show that firms are more likely to issue irregular options when they offer larger option grants, have a less independent board, receive less analyst coverage, have a new CEO, exhibit poor prior performance, have higher stock return volatility, and are smaller in size.