CEO Option Research Articles

CEO Current and Prospective Wealth Option Compensation and Corporate Social Responsibility: The Behavioral Agency Model

This study examines the relationship between CEO options compensation and corporate social responsibility (CSR) based on the behavioral agency model (BAM). The BAM assumes that the CEO is bounded by loss-aversion behavior. Using constructs from the BAM, i.e., CEO current and prospective wealth from their options compensation, this study examines the differing effects of CEO current wealth and prospective wealth on firms’ CSR strengths, CSR concerns, institutional CSR and technical CSR. Based on a sample of 1565 U.S. firms during 1996 to 2018, the study finds that CEO current wealth is negatively related to firms’ CSR strengths and CSR concerns. The study also finds that CEO prospective wealth is positively related to firms’ CSR strengths but is unrelated to CSR concerns. CEO current wealth is negatively related to institutional CSR, whereas CEO prospective wealth is positively related to institutional and technical CSR. CEO current (prospective) wealth is more strongly and negatively (positively) related to institutional CSR than technical CSR. This study indicates that designing CEO option compensation to align top managers’ interests with the stakeholder interests requires a greater understanding of how CEO bounded rationality behavior toward loss aversion and risk taking is influenced by their option compensation.

CEO stock options and corporate climate change: the behavioral agency model and the moderating effect of social capital

Examining the impact of CEO options compensation on corporate adverse impacts on climate change from the perspective of CEO loss aversion and risk-taking, this study argues that higher current (prospective) wealth leads to higher loss aversion (risk-taking) against (toward) corporate climate change. Integrating social capital theory into the behavioral agency model (BAM), the study argues that social capital is negatively related to corporate climate change risk-taking behavior and social capital is moderating the relationship between CEO options compensation and corporate climate change. Using a sample of 1,397 US firms from 2005 to 2019 and various measures of corporate climate change and social capital and estimation methods, it finds evidence to support these hypotheses. This study extends the BAM to explain CEO risk-taking behavior toward climate change and integrates the social capital theory. It offers practical implications to design CEO compensation to reduce the adverse impact of corporations on climate change.

Risk Preferences of Gender‐Diverse Boards: Evidence from CEO Debt‐like Compensation

AbstractWe hypothesize that gender‐diverse boards manage CEO risk‐taking preferences through the debt‐like component of CEO compensation. We provide empirical evidence of a strong positive association between the proportion of independent female directors and debt‐like pension compensation for a sample of US firms. Our key results are robust to a least‐squares framework that includes firm fixed effects to address potential omitted variable bias, and we also find evidence that higher proportions of independent female directors are associated with lower CEO option compensation and more intensive use of restricted stock grants. We obtain corroborating results from a difference‐in‐differences approach using California's 2018 board gender quota law (SB 826) as a quasi‐experiment. Consistently, gender‐diverse boards reduce the cost of debt among firms that are closer to financial distress and for longer maturity bond issues.

The Differential Impact of Executive Stock Options on Systematic and Idiosyncratic Risk: Evidence From Quasi-Experiment

I investigate whether CEO stock options differentially affect the firm’s systematic and idiosyncratic risk. To examine a causal effect of option compensation on the firm’s systematic and idiosyncratic risk, I exploit the passage of Financial Accounting Standard no. 123R as an exogenous shock to CEO option compensation. According to the Capital Asset Pricing Model (CAPM), only systematic risk is priced since investors can eliminate idiosyncratic risk through diversification. Unlike risk-neutral shareholders, risk￾averse CEOs have limited ability to eliminate idiosyncratic (or firm-specific) risk because since they usually hold large positions in their firms and are often prohibited from hedging the firm-specific risk associated with their compensation. Thus, idiosyncratic risk is unwanted by under-diversified CEOs. Consistent with this idea, I find that, although CEO option compensation is positively associated with the total risk, it is negatively associated with the ratio of idiosyncratic to total risk.

CEO option incentives and corporate share repurchases

In this paper, we study the effects of CEOs option incentives on firms' payout and investment policies. On the company's payout side, we find strong evidence that high CEO option sensitivity to stock prices causes more share buybacks and fewer cash dividends. Furthermore, the impact of option incentives on share repurchases is more pronounced when the stock is undervalued. On the investment side, we find that higher exercisable option-delta CEOs direct fewer resources to R&D investments and employment. We use instrument variables two-stage least square regressions and simultaneous system equations regressions to address remaining endogeneity concerns and establish causality. Further analyses reveal that firms in the top exercisable option-delta quintile experience deterioration in performance following buybacks, suggesting that CEOs' repurchasing decisions are significantly influenced by stock price concerns and that they may not act in the best interest of shareholders in the long-term.

When the Going Gets Tough, the Books Get Cooked:Product Market Competition and Financial Misconduct

This paper extends the research on financial misconduct by developing a new perspective based on general strain theory, and more specifically on the strain effect of product market competition. Previous literature suggests that product market competition can provide incentives for managers, but we argue that it can also lead to financial misconduct. In so doing, we take a strain perspective in making the argument that product market competition should be positively associated with the occurrence of misconduct, as it magnifies the threat arising from the possibility of firm liquidation and executive dismissal. We also examine the effect of internal governance mechanisms that are commonly deployed to minimize the agency problem. We argue that CEO option pay will negatively moderate the relationship between product market competition and the occurrence of financial misconduct, in line with the prevailing wisdom of corporate governance research. By contrast, while board independence has often been proposed as an effective governance mechanism to reduce the number of undesirable managerial behaviors, we argue it can exacerbate the threat of executive dismissal resulting from competition, creating incentives for fraudulent behavior. An empirical study of U.S. manufacturing firms provides broad support for our arguments.

Reprint of “Predicting employee wrongdoing: The complementary effect of CEO option pay and the pay gap”

Research examining the influence of executive compensation on organizational wrongdoing has focused on pay’s incentive aspects. However, existing theory in sociology and social psychology has argued that executive pay can also have a social aspect, by increasing feelings of injustice, unfairness and envy. We find evidence that employee wrongdoing may be significantly explained by the simultaneous presence of employee opportunity and motivation for wrongdoing, which relate to the incentive and social aspects of CEO pay, respectively. Using a sample of U.S. banks from 2007 to 2013, we examine the relationship of CEO option pay and the pay gap (i.e., the ratio of CEO total pay to average employee pay) with the likelihood of employee wrongdoing. We find evidence that the pay gap moderates the positive relationship between CEO option pay and the likelihood of employee wrongdoing, suggesting complementarities between the incentive and social aspects of CEO pay.

The relation between CEO equity incentives and the quality of accounting disclosures: New evidence

This paper provides new evidence on the negative relation between CEO equity incentives and accounting disclosure quality. We analyze a comprehensive set of disclosure quality variables, including discretionary accruals quality, the quantity and quality of voluntary disclosures, fineness of reported financial statement information, and the narrative quality of regulatory filings, and use them to create information disclosure quality indices. We address the potential endogeneity of CEO equity incentives by conducting two-stage least squares/IV models and natural experiments created by situations in which there is an exogenous shock to the use or value of CEO stock options. Our results are robust to subsample analyses and to alternative measures of the incentives created by CEO options.

Managerial Sentiment and Employment

We study firms' hiring decisions in a world in which both managers and investors are prone to expectation errors. We show that high managerial sentiment increases employment growth, especially at firms with worse investment opportunities and low-quality corporate governance, and during times of low investor sentiment. Using data on U.S. publicly traded companies and CEO option holdings, we find evidence consistent with these predictions. The results unveil a new channel through which managerial sentiment affects firms' operations, and suggest that managerial optimism can counter the negative effect of pessimistic investors on labor markets.

Predicting employee wrongdoing: The complementary effect of CEO option pay and the pay gap

Research examining the influence of executive compensation on organizational wrongdoing has focused on pay’s incentive aspects. However, existing theory in sociology and social psychology has argued that executive pay can also have a social aspect, by increasing feelings of injustice, unfairness and envy. We find evidence that employee wrongdoing may be significantly explained by the simultaneous presence of employee opportunity and motivation for wrongdoing, which relate to the incentive and social aspects of CEO pay, respectively. Using a sample of U.S. banks from 2007 to 2013, we examine the relationship of CEO option pay and the pay gap (i.e., the ratio of CEO total pay to average employee pay) with the likelihood of employee wrongdoing. We find evidence that the pay gap moderates the positive relationship between CEO option pay and the likelihood of employee wrongdoing, suggesting complementarities between the incentive and social aspects of CEO pay.

The nonlinear relation between financing decisions and option compensation

Recent studies argue that CEO option compensation affects executives’ behavior toward risk. Specifically, the literature provides seemingly conflicting evidence regarding the impact of equity compensation (particularly option holding) on financing activities. We propose and test a nonlinear (e.g., inverted U-shaped) relation between corporate borrowing and option compensation. Consistent with our hypothesis, we empirically show that, in the low range of the option vega, a firm’s debt ratio increases as the option vega increases. However, in the high range of the option vega, we find the opposite relation. Our explanation is based on the contrasting effects of option compensation on managerial incentives toward risk. The positive wealth effect on leverage arises from the convexity of the option compensation, while a negative risk-premium effect exists due to managerial risk aversion. This reconciles the conflicting relation between leverage and option compensation that is often observed in the literature.

CEO compensation, portfolio holdings and strategic investments

PurposeThe purpose of this paper is to examine the relationship of CEO compensation plans and the risk of managerial equity portfolios with the extent of strategic investments in advertising, capital expenditures and research and development (R&D). The elements of compensation are salary, bonuses, options and restricted stock grants. The authors proxy the design of CEO equity portfolios by the price performance sensitivity of the holdings and the portfolio deltas.Design/methodology/approachThe authors use the components of executive compensation and portfolio risk as the dependent variables, regressing these against measures for the level of strategic investment. The authors test for non-linear relationships between the components of CEO compensation and strategic investments. The sample is a broad cross-section from 1992 to 2016.FindingsThe authors find strong support for non-linear relationships of capital expenditures and R&D with CEO bonuses, option grants and restricted stock grants. There are very complex relationships between the components of executive compensation and R&D expenditures, but little evidence of a relationship with advertising expenditures. The authors also find strong complex relationships in the design of CEO equity portfolios with advertising and R&D.Originality/valueLittle earlier research has considered advertising, capital expenditures and R&D in a unified framework. Also, testing for non-linear associations provides much greater insight into the relationship between the components of executive compensation and strategic investment. The findings represent a valuable incremental contribution to the executive compensation literature. The results also have normative policy implications for compensation committees’ design of optimal annual CEO compensation packages to incentivize or discourage particular strategic investment behavior.

Does size affect the relation between option compensation and managerial risk taking? Evidence from Canadian listed companies

AbstractWe examine the effect of CEO option compensation on firm risk in Canadian firms listed on the S&P/TSX index. Results show that there is a robust size effect. Option compensation has a positive and significant effect on firm risk only in small firms and no significant effect in large firms. Moreover, option compensation has no significant effect on firm risk in cross‐listed firms, but within the sample of cross‐listed firms option compensation has a positive and significant effect in small firms only. Overall, our results suggest that CEO compensation is more effective in encouraging risk taking in small Canadian firms.

The Role of Affect in Shaping the Behavioral Consequences of CEO Option Incentives

We advance behavioral agency theory by exploring the influence of mood or “affect” on the behavioral consequences of stock option incentives. Drawing on insights from psychology and behavioral decision theory, we describe how affect influences agent risk behavior. We argue that positive affect amplifies both the extent to which executives reduce strategic risk taking in response to risk bearing and engage in strategic risk taking in response to incentives for further enrichment. Building again on the psychology literature, we describe how CEO accountability attenuates the influence of affect on CEO risk behavior in response to stock option incentives. We test our expectations in a longitudinal data set of CEO stock option incentives, affect, and strategic risk taking by U.S. firms.

Corporate Payout Policy and CEO Compensation Structure

This paper examines how corporate payout policy is affected by CEO compensation structure using data from more than 1,600 firms during 1992-2006. Specifically, it studies the effects of CEO compensation structure, firm characteristics, and dividend payout policies on dividend type and relative dividend size.It finds CEO salary is positively associated with cash dividends, share repurchases, and relative dividend size whereas CEO salary (compared to bonus) as a percentage of total compensation has negative effects on cash dividends and share repurchases. It also discovers CEO stock awards as a percentage of total compensation are positively associated with share repurchases and CEO option awards are negatively related to cash dividends.In addition, this paper shows larger firms and firms with more free cash flow distribute more cash dividends and share repurchases. On the other hand, firms with higher leverage ratio and more investment opportunities prefer to save earnings for future re-investment projects. Finally, it show dividend payout policy (either cash dividends or share repurchases) increases relative dividend size. The results of this study suggest that CEO compensation components affect CEOs’ dividend payout decisions: when CEOs’ stock award increases, they prefer to use share repurchases; when CEOs’ option award increases, they prefer not to use cash dividends.

The social context of compensation design: Social norms and the impact of equity incentives

Drawing on arguments from institutional theory, this study examines how social norms—specifically, local religious social norms—affect the motivational impact of equity‐based incentives. We test our model using longitudinal data on local religious norms, CEO equity incentives, and firm value. Consistent with our theoretical predictions, we find that local religious social norms attenuate the impact of CEO option incentives upon firm value. Furthermore, we find that the attenuating impact of local religious social norms increases with managerial discretion. These findings provide valuable insight for human resource professionals aiming to design compensation contracts for employees that are aligned with firm goals. Our findings also contribute to research on the motivational effect of equity incentives by demonstrating the importance of considering the social context in which executives are embedded.

The Effects of a Tax Notch on CEO Golden Parachute Contracts and Option Exercises

We show that CEO golden parachute contracts are responsive to a tax on golden parachutes, and CEO option exercises are responsive to these contracts. In particular, as a consequence of a tax code provision penalizing parachutes greater than 3 times taxable income, CEO parachute contracts frequently contain “cutback” provisions limiting the parachute to this threshold. When their companies are acquired, CEOs exercise options in bulk to raise their taxable income and boost their threshold. Identification comes from a difference-in-difference-in-difference exploiting a discontinuous change in exercise incentives over time and variation across CEOs in contract incentives and deal timing.

CEO Risk-Taking and Socioemotional Wealth: The Behavioral Agency Model, Family Control, and CEO Option Wealth

We combine behavioral agency and family business literature to analyze the role of dominant firm principals in constraining the managerial agent’s (CEO’s) response to equity-based pay. Behavioral agency research has made progress in understanding CEO risk behavior in response to equity-based incentives and family firm risk behavior driven by concentrated socioemotional and financial firm-specific risk bearing. However, both literatures have evolved independently, which has limited our understanding of how the risk bearing of agent and principal influences the predictions of the behavioral agency model (BAM). We combine these literatures in order to enhance BAM’s predictive validity with regard to firm risk-taking as a function of both agent and principal risk preferences. Our findings suggest that family principals are more likely than nonfamily principals to constrain CEO risk behavior that is perceived as immoderate (excessively risk averse or excessively risk seeking). We also offer evidence that CEO ties to the family influence the CEO’s response to equity-based incentives. In doing so, we offer refinements to BAM’s formulation and advance our understanding of the unique nature of agency problems within family firms.

Management of income statement variables to report small positive earnings numbers

PurposeCharting the earnings numbers reported by Korean firms produces a bell curve, but for a sharp discontinuity in the area surrounding zero. The purpose of this paper is to investigate if and how a large segment of Korean managers might manage accounting numbers to produce the observed result.Design/methodology/approachThis study adopts an empirical research method using Korean listed firms as a sample. The primary focus of investigation is on major income statement variables that might produce the observed results in earnings from operations and net income.FindingsManagers of Korean firms opportunistically use almost all income statement variables to influence earnings numbers. They manage revenues and selling, general & administrative expenses to report small positive earnings from operations, but manage non-operating gains (losses) to report small positive net income.Research limitations/implicationsThis paper does not answer several questions related to loss avoidance. First, the paper did not examine which actions, such as discretionary accruals, opportunistic business decisions, or bogus transactions, were employed to affect line items on the income statement. Second, the paper did not investigate what specific incentives trigger Korean managers to report small positive earnings. Korean firms have traditionally raised capital by borrowing funds from creditors and governmental agencies. Thus, they may be concerned that reporting losses would reduce their borrowing capacity. Finally, corporate governance, such as CEO tenure and option grants may influence the extent of earnings management to avoid losses, but most corporate governance data for Korean companies must be manually collected. Accordingly, these subjects are left for future studies as well.Originality/valueThis study contributes to accounting literature by reporting how managers of Korean firms artificially coordinate major income statement variables and report small positive earnings figures, noting the differences between earnings management investigating methodology and ones used in previous studies.

Equity Incentives, Disclosure Quality, and Stock Liquidity Risk

We provide evidence that CEO equity incentives, especially stock options, influence stock liquidity risk via information disclosure quality. We document a negative association between CEO options and the quality of future managerial disclosure policy. Contributing to the literature on CEO risk-taking, we document a positive association between CEO options and future systematic stock liquidity risk. Controlling for endogeneity, we show that information disclosure quality is an important channel through which CEO options influence stock liquidity risk. Results are robust to various controls for endogeneity and to the use of numerous disclosure quality and stock liquidity risk measures.