CEO Stock Option Grants Research Articles

Changes in CEO stock option grants: A look at the numbers

We study changes in the number of CEO stock option grants. Despite some evidence of short-term rigidity, the number of options granted changes frequently over time. CEOs of firms with unusual investment patterns subsequently receive fewer stock options as part of their compensation packages. CEOs who hold exercisable deeply-in-the-money options (overconfident CEOs) also receive fewer stock options in subsequent periods. Our results show that past CEO behavior predicts stock option grants. These insights can inform theoretical discussion on option-granting behavior and, more broadly, on the board's re-contracting process.

Unintended Consequences: Information Releases and CEO Stock Option Grants

Scholars, regulators, and practitioners have long struggled with challenges emanating from the separation of ownership and control of modern corporations. Agency theory typically prescribes the use...

The effects of accounting conservatism on executive compensation

PurposeThe purpose of this paper is to identify means of better associating executive remuneration with managerial decision making and firm performance.Design/methodology/approachThe authors evaluate the influence of conditional accounting conservatism on CEO compensation. The authors focus particularly on the ex ante pay-for-performance sensitivity (PPS) of CEO stock option grants. The empirical method used is panel data regression.FindingsThe authors find that accounting conservatism is positively related to the PPS of CEO option-based compensation. The effects of accounting conservatism on the PPS of options are more significant for firms with relatively weaker corporate governance and for the period before the introduction of FAS 123R. The findings suggest that directors reward CEOs for adopting accounting conservatism, both in general terms and incrementally, and that rewards are channelled through incentive-linked compensation. The results are also consistent with the view that accounting conservatism compliments other mechanisms, such as corporate governance, in reducing information asymmetry and agency problems between managers and shareholders and other stakeholders.Originality/valueThis paper provides a number of important contributions to the literature. It is the first to identify a relationship between accounting conservatism and option-based CEO compensation, which has important potential contracting and enforcement implications due to the incomplete nature of option contracts and the reward and risk attributes of CEOs. This paper is also the first to analyse the association between conditional accounting conservatism and CEO compensation at the firm–year level, by employing the firm–year conservatism score approach proposed by Khan and Watts (2009). This provides for greater insight regarding the interaction between accounting conservatism and other firm-specific elements than is otherwise obtainable from an overall firm or year interpretations derived from the traditional Basu (1997) asymmetric timeliness model approach. Furthermore, this paper also provides a comparison of the relative association of accounting conservatism on both explicit and implicit forms of CEO compensation for the same firm sample. This allows for the assessment of whether accounting conservatism relates differently to incentive-based CEO remuneration relative to ex post CEO compensation outcomes.

Backdating of executive stock options: comparing financial and nonfinancial industries

PurposeThe 2008-2009 subprime mortgage crisis in the USA caused bankruptcies and closures of many financial institutions. Yet many CEOs of US financial institutions were awarded huge bonuses and pay packages despite the economic collapse, suggesting that their incomes were not in conjunction with those of the shareholders, indicating a serious agency problem. This issue raises the question as to whether stock option backdating, another example of an agency problem, was as prevalent as slack lending policies among these financial institutions. This paper aims to compare the relative magnitude of executive option backdating in financial and nonfinancial firms.Design/methodology/approachUsing a sample of CEO stock option grants from 1995 to 2006, obtained from ExecuComp, the authors employ an event study around the grant dates of executive options. The authors compare the abnormal price movements between financial and nonfinancial firms.FindingsThe abnormal negative stock returns were found before the award dates for both groups of firms. The after-event abnormal returns of both groups of firms, however, show different trends. For nonfinancial firms, there is an immediate turnaround of the abnormal return movement right after the grants; that is, the price increases, indicating the occurrence of significant backdating events. For financial firms, however, there is no significant price rebound after the grant date. In fact, the price continued to decline throughout the after-event period.Research limitations/implicationsThe result shows that nonfinancial firms demonstrate significantly more option backdating behavior than financial firms.Practical implicationsThe findings suggest that previous findings on prevalent backdating among all public listed firms are only partially correct. This paper shows that backdating behavior found in previous studies is indeed driven by nonfinancial firms. This unexpected finding contradicts the initial prediction of authors that option backdating may be more likely among financial firms.Originality/valueBased on previous research, the authors recognize that generally the official grant dates of firms must have been set retroactively, as shown by Lie (2005). The findings, however, show that financial firms demonstrate only partial backdating behavior. This study opens a path for future research to further discover why financial firms exhibit less backdating behavior compared with nonfinancial firms, and if option backdating is not an issue for financial firms, why the share prices of these firms decline significantly prior to the grant date.

Cash Holding in U.S. Firms: Evidence from FAS 123R

Using exogenous variation in CEO stock option grants generated by FAS 123R which mandated expensing of employee stock options, we investigate the causal effects of CEO risk incentives (vega) on cash policies of U.S. firms. Employing a difference-in-difference framework, in which we identify firms most affected by the regulatory change, we find no evidence that changes in CEO portfolio vega lead to significant changes in corporate cash holdings and the marginal value of cash. Our evidence challenges the view that option-based compensation is a first-order driver of corporate cash policy and instead implies that previously documented associations perhaps reflect endogeneity rather than a causal influence.

Are CEOs Held Accountable for Unrecognized Expenses? The Case of Implied Employee Option Expense

An extensive body of research has investigated whether CEOs are held accountable for various earnings components by testing the sensitivity of CEO cash compensation to these earnings components. No study, however, has examined whether CEOs are held accountable for expenses unrecognized in earnings. This study investigates whether CEOs were held accountable for fair value employee stock option (ESO) expense in the period 1996-2005, during which the expense was not recognized, but rather implied by pro forma earnings disclosed in the footnotes under SFAS No. 123. Controlling for CEO stock option grants and other variables, I find that CEO cash compensation decreased with implied fair value ESO expense in the second half of the period 1996-2005 but not in the first half. The result represents the first evidence that CEOs can be held accountable for unrecognized expenses and how boards of directors view an unrecognized expense may be influenced by public opinions (accounting for fair value ESO expense was hotly debated in late 1990s and early 2000s). In high-tech industries, however, the result is very different. In these industries, CEO cash compensation was related to fair value ESO expense in neither the first half nor the second half of the period 1996-2005. The result is unsurprising given the strong position taken publicly by high-tech industry leaders that fair value ESO expense is not an expense to the firm and cannot be measured accurately.

CEO opportunism?: Option grants and stock trades around stock splits

Decades of research confirm that, on average, stock split announcements generate positive abnormal returns. In our sample, 80% of CEO stock option grants are timed to occur on or before the split announcement date. With the average market-adjusted announcement return of 3.1%, awarding the grant before the split announcement results in an average gain per CEO-grant of $451,748. We find additional evidence consistent with timing of CEO stock trading around the split announcement. In the case of CEO stock sales, about two-thirds occur after the split announcement, resulting in an average gain of $345,613.

Corporate Investment and Changes in CEO Stock Option Grants

We study changes in CEO stock option grants. Unlike most of the literature, we focus on the number rather than the value of options granted. We first provide a detailed description of the main aggregate trends in CEO stock option grants. We then consider the cross-sectional heterogeneity in option-granting activity. We find that CEOs who either overinvest or underinvest subsequently receive fewer stock options as part of their compensation packages. CEOs who hold exercisable deeply-in-the-money options (overconfident CEOs) also receive fewer stock options in subsequent periods. Our findings provide insights into the dynamics of CEO compensation contracts.

Managerial Stock Options and Firm Risk: The Impact of Regulatory Changes

We provide evidence that there has been a fundamental change in the relationship between managerial risk taking incentives and firm risk after 2002, a period characterized by significant regulatory changes concerning executive compensation practices in public corporations. A consequence of the regulatory changes is a drop in CEO stock option grants, translated into significantly lower risk-taking incentives. We show that firms with different risk profiles have responded to regulatory changes differently. Riskier firms decreased the stock option grants, thus risk-taking incentives to their CEOs the most. Yet, the changes in risk-taking incentives have not been accompanied by changes in firm risk. As a result, the relationship between managerial risk-taking incentives and firm risk becomes negative in the post-regulatory era.

Timing of CEO Stock Option Grants and Corporate Disclosures: New Evidence from the Post-SOX and Post-Backdating-Scandal Era

Extant studies provide two additional explanations other than backdating for the abnormal stock returns around CEO option grants – timing of option grants and timing of corporate disclosures. We examine the effect of the Sarbanes-Oxley Act of 2002 (SOX), the stock option backdating scandal, and the new compensation disclosure rules of 2006 on these opportunistic timing behaviors. We find no evidence of opportunistic timing relative to scheduled option grants in the pre-SOX, post-SOX, and post-Backdating-Scandal periods. However, opportunistic timing behaviors for unscheduled option grants exist in the pre-SOX period and persist in the post-SOX period. In addition, we distinguish timing of option grants from timing of corporate disclosures by categorizing quarterly earnings announcements into fixed and variable dates and find the persistence of both types of timing behaviors. We also analyze option grants to independent directors and find no evidence of timing behaviors in all three sample periods. Overall, our results suggest that SOX does not affect opportunistic timing behaviors related to CEO option grants. However, the backdating scandal combined with the subsequent compensation disclosure rules have deterred these behaviors.

Is There a Firm-Size Effect in CEO Stock Option Grants?

Schaefer (1998) and Baker and Hall (2004) posit a firm size effect for regular executive compensation but not specifically for executive stock option grants. They propose an inverse relation between pay-performance sensitivity and firm size along with a positive relation between the marginal productivity of executive effort and firm size. The product of pay-performance sensitivity and executive productivity is 'incentive strength'. They find a weakly positive association between incentive strength and firm size. We substitute Hall and Murphy's (2002) pay-performance sensitivity metric to detect a firm size effect in CEO stock option grants. After adjusting for small-firm risk aversion and private diversification 'clienteles', we document evidence of a residual small-firm effect impacting on incentive strength principally through grant size. Given lower small-firm deltas, grant size appears to have been increased by compensation committees to ensure small-firm CEOs are not under-compensated relative to their large-firm counterparts. We also find that firm complexity influences pay-performance sensitivity as well, but not labor productivity (proxying for CEO productivity). No evidence is found that firm smallness and complexity impact on labor productivity. However, we empirically confirm a negative relation between pay-performance sensitivity and firm smallness and, by implication, firm complexity.

Is there a firm-size effect in CEO stock option grants?

Schaefer (1998) and Baker and Hall (2004) posit a firm size effect for regular executive compensation but not specifically for executive stock option grants. They propose an inverse relation between pay-performance sensitivity and firm size along with a positive relation between the marginal productivity of executive effort and firm size. The product of pay-performance sensitivity and executive productivity is „incentive strength‟. They find a weakly positive association between incentive strength and firm size. We substitute Hall and Murphy‟s (2002) pay-performance sensitivity metric to detect a firm size effect in CEO stock option grants. After adjusting for small-firm risk aversion and private diversification „clienteles‟, we document evidence of a residual small-firm effect impacting on incentive strength principally through grant size. Given lower small-firm deltas, grant size appears to have been increased by compensation committees to ensure small-firm CEOs are not under-compensated relative to their large-firm counterparts. We also find that firm complexity influences pay-performance sensitivity as well, but not labor productivity (proxying for CEO productivity). No evidence is found that firm smallness and complexity impact on labor productivity. However, we empirically confirm a negative relation between pay-performance sensitivity and firm smallness and, by implication, firm complexity.

CEO Stock Option Grants: The Economic Consequences of Revelation of Backdating and the Confounding Effect of Good-Timing of Earnings Disclosure

This paper examines the economic consequences of the revelation of CEO stock option backdating and the confounding effect of the good-timing of earnings disclosure in explaining the pattern in stock returns around option grant dates. First, we investigate 136 firms identified in the Wall Street Journal (WSJ) as of December 2006 as having been implicated in option backdating. Using the CRSP 2006-2007 data, we find that the economic loss upon the revelation of backdating is $129 billion and that it is significantly associated with the potential option expenses. Second, using a full sample from the Thomson Financial Insider Filing Database, we document that backdating and good-timing jointly existed in the full sample before the Sarbanes-Oxley Act of 2002 (SOX). Moreover, our evidence suggests that while the SOX mitigates the backdating problem, the trough pattern in stock returns around option grant dates in the post-SOX period is mainly driven by good-timing.

At-the-Money vs. Non-At-the-Money CEO Stock Option Grants

At-the-Money vs. Non-At-the-Money CEO Stock Option Grants

Backdating of CEO Stock Option Grants and Timing of Earnings Disclosures

Extant studies provide two competing explanations for the abnormal stock return patterns around CEO option grants: the backdating of option grants and the timing of news disclosure. We examine the interrelation between backdating, good-timing, and the regulatory effect on such opportunistic behaviors. Using the CEO option grant sample for SP (2) while the Sarbanes-Oxley Act (SOX) curtailed backdating, the good-timing of earnings disclosures as an alternative device has persisted and increased post-SOX; and (3) the reporting lag between the grant date and the SEC filing date is an indicator of good-timing rather than backdating post-SOX. Overall, our evidence suggests that despite the tightened oversight represented by SOX, CEOs continue to manipulate the timing of earnings disclosures to increase the value of their equity compensation. JEL Classification: M41; M52; K22; G38

CEO Stock Options and Equity Risk Incentives

Abstract: We test the hypothesis that the risk incentive effects of CEO stock option grants motivate managers to take on more risk than they would otherwise. Using a sample of mergers we document that the ratio of post‐ to pre‐merger stock return variance is positively related to the risk incentive effect of CEO stock option compensation but this relationship is conditioned on firm size, with firm size having a moderating effect on the risk incentive effect of stock options. Using a broader time‐series cross‐sectional sample of firms we find a strong positive relationship between CEO risk incentive embedded in the stock options and subsequent equity return volatility. As in the case of the merger sample, this relationship is stronger for smaller firms.

The Timing of CEO Stock Option Grants: Scheduled versus Unscheduled Awards

This study seeks to provide insights into companies' decisions to issue stock options to CEOs on a scheduled or an unscheduled basis. We first document that unscheduled option awards provide CEOs with greater flexibility to influence the grant date stock price that leads to a lower exercise price of options and a higher accreted value realized at exercise. We then investigate whether the choice between unscheduled and scheduled awards is affected by the degree of CEO influence and the importance of stock options in CEO compensation. Consistent with expectations, we find that firms with greater CEO influence over compensation committees and boards and firms with greater use of stock options in CEO compensation are more likely to issue options to CEOs on an unscheduled basis. We also examine whether compensation committees and boards are effective in limiting CEOs' option timing manipulation for unscheduled awards and information timing manipulation for scheduled option awards. We find that, for firms that issue unscheduled options, boards that are less independent of management and that receive a greater proportion of director compensation from stock options allow greater management opportunism with respect to the timing of option awards. In contrast, for firms that issue scheduled options, we find no significant impact of board independence and director option compensation on the extent of management opportunism with respect to the timing of information releases around option awards.

Non-Management Director Options, Board Characteristics, and Future Firm Investments and Performance

This paper examines if non-management director pay packages are set in ways consistent with the optimal contracting theory. Under this theory, directors issue stock option grants as a means for providing non-management directors incentives to monitor adequately the risk-taking and investment opportunities that managers of the firm undertake. Our results are consistent with this theory. Using a sample of over 5,200 observations between 1997 and 2002, we find that (1) agency costs differ substantially across our sample, (2) boards systematically set their compensation contracts to address these agency costs, and (3) significantly positive links exist between the ratio of current stock option grants-to-total compensation and seven future investment, risk and firm performance variables. The investment variables are next period's change in research and development expenditures and change in capital expenditures. The risk variable is next year's stock return volatility. The firm performance variables are next period's Tobin's Q ratio, return on assets (ROA), a market return on current investments, and this period's stock return. Our results are incremental to board characteristics, CEO stock option grants, and economic, firm-specific, yearly, and industry control factors.

The Structure of Corporate Ownership: Causes and Consequences

This paper argues that the structure of corporate ownership varies systematically in ways that are consistent with value maximization. Among the variables that are empirically significant in explaining the variation in ownership structure for 511 U.S. corporations are firm size, instability of profit rate, whether or not the firm is a regulated utility or financial institution, and whether or not the firm is in the mass media or sports industry. Doubt is cast on the Berle-Means thesis, as no significant relationship is found between ownership concentration and accounting profit rates for this set of firms.