Executive Options Research Articles

Sweet Fees and Remedies on Stock Buybacks (#3) - Intel Case Study

A case study of Intel's 2004-2007 buybacks extends a series of reports on the division in buyback benefits between shareholders and management options. Intel spends $23.1 billion to repurchase 14.3% of its outstanding shares. The stock subsequently rises 0.7%. Intel shareholders by -$0.05 (-0.2%) before tax due to the direct effect of the buyback; Intel executives benefit by up to $3.46 per option. Future stock price fluctuations will change actual returns on Intel's buybacks, but the advantage to executive (and employee) options will persist. In addition to salary and bonus for running operations, execs with options receive hedge fund type 2/20 fees from their buyback work. The skewed returns are paid by shareholders and tilt management preferences towards buybacks at the expense of dividends and/or business reinvestment. Four remedies are suggested to rebalance dividend, buyback, and reinvestment incentives. Companies should report: 1) Absolute accretion from buybacks2) Option expense at time of exercise3) Monthly VWAP at time of buybacks4) Income on buybacks

Neighborhood Matters: The Impact of Location on Broad Based Stock Option Plans

We find that fixed effects related to the location of a firm's headquarters explain variation in broad based option grants after controlling for industry effects and firm characteristics traditionally known to affect option granting. Location matters because of local labor market conditions and social interaction with neighboring firms. Broad based option grants are higher (i) when the firm's stock prices co-move more with stock prices of other firms located in that Metropolitan Statistical Area (MSA); (ii) in states that are less likely to enforce non-compete agreements; and (iii) in MSAs where employees prefer options because firms there have enjoyed abnormally high stock returns. Social influence affects broad based option grants because firms grant more options to rank and file workers when other firms in the MSA grant more broad based options. The neighborhood's option granting practices matter most when the firm is located in a region with a highly educated work force. All results with the exception of the impact of non-compete agreements hold when firms located in California are excluded. However, these results do not hold for top executive option grants.

How Execs Earn Sweet Fees on Buybacks (#2) - Nvidia Case Study

Absolute analysis of accretion is a definitive measure of a buyback's contribution to shareholder wealth. In a case study of a world class corporation, NVIDIA spends $0.6 billion to repurchase 8.0% of its outstanding shares. The stock subsequently rises 90.1%. Absolute analysis shows ongoing NVIDIA shareholders benefit by $1.35 (3.8%) before tax considerations due to the direct effect of the buyback; managers benefit by up to $2.96 per option. Management option holders receive 30.9% of the buyback's stock price appreciation, akin to a 1.7/20 hedge fund fee structure for executive option holders. The small shareholder benefit, large gain for options, and sizable trading activity beg the questions: Should shareholder returns on buybacks be reported? Do benefits adequately compensate for 10b-18, 10b5-1, insider trading and option compensation governance liabilities?

Does backdating explain the stock price pattern around executive stock option grants?

Extant studies show that stock returns are abnormally negative before executive option grants and abnormally positive afterward. We find that this return pattern is much weaker since August 29, 2002, when the Securities and Exchange Commission requirement that option grants must be reported within two business days took effect. Furthermore, in those cases in which grants are reported within one day of the grant date, the pattern has completely vanished, but it continues to exist for grants reported with longer lags, and its magnitude tends to increase with the reporting delay. We interpret these findings as evidence that most of the abnormal return pattern around option grants is attributable to backdating of option grant dates.

Sensitivity of executive wealth to stock price, corporate governance and earnings management

PurposeThis paper seeks to investigate whether executive wealth sensitivity to stock price fluctuations serves as an incentive for earnings management.Design/methodology/approachUsing a sample of 475 chief executive officers (CEOs) from 410 randomly selected Standard and Poor's (S&P) 1500 firms, the relation between executive stock‐based compensation, corporate governance, and earnings management is empirically examined.FindingsCEO wealth sensitivity is positively associated with abnormal accrual usage and the relation is consistent with income‐smoothing. Also find that governance does not significantly influence the association between CEO stock‐based wealth sensitivity and earnings smoothing.Research limitations/implicationsThis study has several limitations. First, it is assumed that the accruals models used provide accurate measures of abnormal accruals. Several recent studies question the reliability of these models. Second, the wealth sensitivity measures in this paper are based on Black Scholes option pricing. A number of the assumptions underlying Black Scholes do not hold for executive options. Finally, governance factors that influence the examined relations may not be effectively captured by the measures in this paper.Practical implicationsThe findings have implications for compensation design. Unintended consequences of high CEO exposure to firm‐specific risk may not be effectively mitigated by governance. These results also have potential policy implications. In the wake of recent accounting scandals regulators tightened governance standards for corporate. The findings suggest that reliance on these standards as deterrents to earnings management may not be warranted.Originality/valueThe study contributes to both the earnings management and corporate governance literatures. The results of this study suggest that CEO stock‐based wealth sensitivity is an earnings management incentive.

Some Observations on the Stock Option Backdating Scandal of 2006

The corporate stock option backdating scandal has dominated business page headlines during the summer of 2006. The SEC is currently investigating more than seventy-five companies with respect to the timing and pricing of stock options granted during the boom years of the late 1990s and early 2000s, and the number of firms caught up in the scandal seems to increase every day. This essay contributes to our understanding of the backdating phenomenon by analyzing the economics of backdating and the characteristics of the firms under investigation. Its main points are the following: First, given the high volatilities of the stocks of the technology companies that dominate the list of firms under investigation and the fact that options granted to executives and employees typically may not be exercised for several years, press reports that focus on the size of the strike price discounts achieved by backdating significantly overstate the value of backdating. In some cases, reducing the strike price by a dollar per share by backdating increased the Black-Scholes value of the option by less than twenty cents per share. Second, completely unnoticed in the discussion so far is the fact that in many cases backdating dramatically reduced the apparent value of options. Because the size of executive stock option grants often is determined first by establishing the value to be delivered and then by calculating the number of shares to be covered by the option, reducing the apparent value of option shares may have substantially increased the size and true economic value of backdated executive option grants. Third, comparison of semiconductor firms under investigation for backdating with peer companies that are not suggests an association between backdating and the use of options in compensating non-executive employees. This essay considers several explanations for backdating non-executive options, including share limitations, minimizing apparent rank and file compensation, and cognitive biases. Finally, this essay argues that the backdating phenomenon is really not an accounting scandal. Backdating has accounting consequences, but it is unlikely to have been accounting driven.

Are Performance Conditions on Executive Options Driven by Fundamentals?

A special feature of UK executive pay is the heavy reliance on performance conditions for executive share options. Using data compiled from 2002-2003 Remuneration Committee reports of 130 of Britain's largest companies as well as linked data on analyst earnings forecasts and realised earnings, this paper computes probabilities of Britain's CEOs meeting their performance conditions and how much this varies across firms. Our main findings are that there is not much cross-company variation in how tough performance conditions are, though there are some outliers. We also find that the probability of meeting the targets depends on certain fundamental variables such as the number of non-executive directors, salaries of the chairs of the remcom committees, CEO tenure, CEO base pay and CEO notice periods. While most of the variables have the some sign as expected from theory, the statistical relations are weak. Overall, our results provide some support that good corporate governance leads to tougher targets for CEOs but at the some time the weakness of these links suggests that there is still much room for improvement.

Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders

We test the signaling and wealth transfer hypotheses around the announcement of share repurchases using a recent and larger sample of data than previously examined while employing a methodology designed to enhance the power of our tests. Disentangling the wealth transfer and signaling hypotheses is difficult; they are not mutually exclusive and can have opposite effects for bondholders. Wealth transfers will decrease bondholder wealth while positive signals will increase it; the combined effects obscure tests of each hypothesis. By focusing on sub-samples where signaling is more and less likely to be present we increase our ability to isolate the separate effects. In addition to traditional tests of wealth effects, we feature information inherent in the relation of wealth changes to equity and debt. Also, it is important to examine more recent evidence surrounding repurchases, particularly for bondholders. Most work on wealth changes to bondholders ends in 1997 with the demise with the Lehman Brothers Bond Database. Our results are generally consistent with the positive signaling effect of stock repurchases, but also provide some support for wealth transfer. Our work also emphasizes the importance of trying to disentangle the various hypotheses. In the subset of option funding repurchases, where signaling effects are less likely, the positive correlation of wealth changes between stockholders and bondholders is completely eliminated. Bond ratings are much more likely to be upgraded in samples without executive options which is precisely where the signaling effects are expected to be concentrated. Governance factors are insignificant.

Empirical evidence on the use, size and cost of executive options schemes in Australia

In this paper we provide an overview of empirical data relating to the use, scale and cost of executive options schemes in Australia. Our data is based on a sample of 100 large listed Australian corporations. Our data suggests that approximately 80% of large listed corporations in Australia presently employ executive options schemes, but that the size and cost of these schemes reduced significantly after 2000. We argue that this reflects the impact of increased public scrutiny over options schemes and the impending move in Australia towards a financial reporting regime in which treating the cost of options as an expense for the purposes of calculating annual profit and loss is mandatory.

Executive Options Plans and Firm Performance - Bigger isn't Better

Executive options represent a phenomenon of particular economic significance. Just as their use has ballooned over the past decade, so too has the literature concerning their nature, cost and impact. However, despite the growth in the volume of literature devoted to the topic of executive options, there appears to be little agreement as to the performance impact brought about in consequence of the decision by firms to introduce executive options into their remuneration mixes. This paper contributes to the literature by providing evidence relating to the impact of options plans on firm financial performance. In particular, evidence is presented which suggests that option plan size (as measured by the portion of outstanding equity capital covered by options grants) and options holding concentration (the degree to which options granted under a plan are concentrated into the hands of the firm's most senior managers) have a significant impact on the manner in which executive options plans impact on firm financial performance.

Share Repurchases, Dividends and Executive Options: the Effect of Dividend Protection

We study the determinants of share repurchases and dividends in Finland. We find that higher foreign ownership serves as a determinant of share repurchases and suggest that this is explained by the different tax treatment of foreign and domestic investors. Further, we also find support for the signalling and agency cost hypotheses for cash distributions. The fact that 41% of the option programmes in our sample are dividend protected allows us to test more directly the ‘substitution/managerial wealth’ hypothesis for the choice of distribution method. When options are dividend protected, the relationship between dividend distributions and the scope of the options programme turns to a significantly positive one instead of the negative one documented in US data.

The configuration of long‐term executive directors incentive schemes

PurposeThe Article seeks to identify the configuration of executive directors conditional option and LTIP arrangements used to align the interest of the company’s directors and shareholders.Design/methodology/approachThe article presents an empirical study of the option and LTIP arrangements (current and previous) of 51 major UK companies. The article focuses on the configuration of option schemes and LTIPs in respect of three critical elements: the performance target selected, the comparator used to benchmark performance and the quantitative performance target level requirement to be achieved to trigger rewards. The period 1989‐2002, covered by the research indicates a substantial degree of “experimentation” with many companies amending their original option schemes and LTIPs and a larger number of other companies introducing new arrangements. A substantial number of schemes can be characterised as being “undemanding” rewarding average rather than excellent performance.Research limitations/implicationsIt is It is proposed (in a follow up paper) to econometrically test for associations between particular configurations (identified in this article) and actual corporate financial performance, i.e. which configurations have the most robust impact on performance.Practical implicationsThe author makes a number of recommendations aimed at making option schemes and LTIP, more “stretching”, rewarding only excellent rather than average performance.Originality/valueThis is the first paper to explicitly look at the components of option schemes and LTIPs in a detailed way, questioning the merits/demerits of the targets and comparators commonly used to evaluate performance.

On Target: An Examination of CEO Stock Option Performance Hurdles

In this paper, we have looked at the choice of performance targets using a unique panel database on UK CEO executive option performance targets. Using this data on performance targets along with governance data and financial data for company accounts with year ends from 2001 to 2003, we find that the rate of switch in types of targets and in levels of targets has been slow. Furthermore, those with high levels of institutional shareholding are less likely to use pure EPS targets, perhaps because that pure EPS targets are inconsistent with the relative performance targets predicted by agency theory. We find confirmation of the correlation between levels of targets and average analyst estimates of earnings but at the same time higher forecasts only translate into weakly higher targets. We also conclude it is difficult to predict changes in targets from any variables in our dataset and indeed when changes in target levels occur they tend to be rather large.

THE UTILITY-BASED VALUATION AND COST OF EXECUTIVE STOCK OPTIONS IN A BINOMIAL FRAMEWORK: ISSUES AND METHODOLOGIES

Journal of Derivatives AccountingVol. 02, No. 02, pp. 165-188 (2005) ARTICLESNo AccessTHE UTILITY-BASED VALUATION AND COST OF EXECUTIVE STOCK OPTIONS IN A BINOMIAL FRAMEWORK: ISSUES AND METHODOLOGIESDON M. CHANCE and TUNG-HSIAO YANGDON M. CHANCEDepartment of Finance, Louisiana State University, 2163 CEBA, Baton Rouge, LA 70803, USACorresponding author. Search for more papers by this author and TUNG-HSIAO YANGDepartment of Finance, Louisiana State University, 2163 CEBA, Baton Rouge, LA 70803, USA Search for more papers by this author https://doi.org/10.1142/S0219868105000392Cited by:5 PreviousNext AboutSectionsPDF/EPUB ToolsAdd to favoritesDownload CitationsTrack CitationsRecommend to Library ShareShare onFacebookTwitterLinked InRedditEmail AbstractOptions are among the most important forms of compensation and incentive structuring. Standard option pricing theory provides guidelines but not a conclusive prescription of how to value executive stock options. Academic research on this subject has gone in several related but distinct directions. This paper examines one thread of this research stream: binomial models based on expected utility. We start by illustrating the procedures for estimating executive option values using expected utility analysis in a binomial framework. Using a common set of inputs based on empirical data, we compare option values and company costs based on differences in inputs and assumptions. Our findings identify variables that are important and others with relatively minor impact. We also examine the effect of dividends on executive stock options values, a topic that has been largely ignored to date. We present the argument for why the economic cost of an option equals its economic value, which contrasts with standard accounting procedures. This conflict between economics and accounting, while not new, can explain why corporations are so uncomfortable with new accounting rules for expensing executive stock options.Keywords:Executive stock optionsbinomial modelutility References D. Aboody, Journal of Accounting and Economics 22, 357 (1996). Crossref, Google Scholar M. Avellaneda and P. Laurence , Quantitative Modelling of Derivative Securities from Theory to Practice ( CRC Press , Boca Raton, FL , 1999 ) . Google ScholarJ. N. Carpenter, Journal of Financial Economics 48, 127 (1998). Crossref, Google Scholar N. Chriss , Black–Scholes and Beyond: Option Pricing Models ( Irwin Professional Publishing , Chicago , 1997 ) . Google Scholar Core, J. and W. Guay (2003). When efficient contracts require risk–averse executives to hold equity: implications for option valuation, for relative performance evaluation, and for the corporate governance debate, Wharton School Working Paper . Google ScholarJ. Detemple and S. Sundaresan, The Review of Financial Studies 12, 835 (1999). Crossref, Google Scholar Financial Accounting Standards Board (2004). Statement of Financial Accounting Standards No. 123: Share–Based Payment (Revised 2004). Financial Accounting Series Exposure Draft, December . Google ScholarB. J. Hall and K. J. Murphy, Journal of Accounting and Economics 33, 3 (2002). Crossref, Google ScholarS. Huddart, Journal of Accounting and Economics 18, 207 (1994). Crossref, Google ScholarJ. Hull and A. White, Financial Analysts Journal 60, 114 (2004). Crossref, Google Scholar P. Jackson and M. Staunton , Advanced Modelling in Finance Using Excel and VBA ( Wiley , Chichester, UK , 2001 ) . Google Scholar R. Jarrow and S. Turnbull , Derivative Securities ( SouthWestern , Cincinnati , 2000 ) . Google ScholarN. Kulatilaka and A. J. Marcus, Financial Analysts Journal 50, 46 (1994). Crossref, Google ScholarR. Merton, The Review of Economics and Statistics 51, 247 (1969). Crossref, Google ScholarR. Merton, Journal of Economic Theory 51, 373 (1971). Google ScholarL. K. Meulbroek, Financial Management 30, 5 (2001). Crossref, Google Scholar E. K. Prisman , Pricing Derivative Securities: An Interactive Dynamic Environment with Maple V and Matlab ( Academic Press , San Diego , 2000 ) . Google Scholar J. J. Siegel , Stocks for the Long Run , 2nd edn. ( McGraw-Hill , New York , 1998 ) . Google Scholar FiguresReferencesRelatedDetailsCited By 5ESO Valuation with Job Termination Risk and Jumps in Stock PriceTim Leung and Haohua Wan1 Jan 2015 | SIAM Journal on Financial Mathematics, Vol. 6, No. 1Non-marketability and the value of employee stock optionsMenachem Abudy and Simon Benninga1 Dec 2013 | Journal of Banking & Finance, Vol. 37, No. 12Employee Stock Option Valuation under Levy ModelsTim S. T. Leung and Haohua Wan1 Jan 2013 | SSRN Electronic Journal, Vol. 41Executive Stock OptionsRobert W. Kolb29 November 2011ACCOUNTING FOR RISK AVERSION, VESTING, JOB TERMINATION RISK AND MULTIPLE EXERCISES IN VALUATION OF EMPLOYEE STOCK OPTIONSTim Leung and Ronnie Sircar1 Jan 2009 | Mathematical Finance, Vol. 19, No. 1 Recommended Vol. 02, No. 02 Metrics History KeywordsExecutive stock optionsbinomial modelutilityPDF download

Empirical Evidence on the Use Size and Cost of Executive Options Schemes in Australia

In this paper we provide an overview of empirical data relating to the use, scale and cost of executive options schemes in Australia. Our data is based on a sample of 100 large listed Australian corporations. Our data suggests that approximately 80% of large listed corporations in Australia presently employ executive options schemes, but that the size and cost of these schemes reduced significantly after 2000. We argue that this reflects the impact of increased public scrutiny over options schemes and the impending move in Australia towards a financial reporting regime in which treating the cost of options as an expense for the purposes of calculating annual profit and loss is mandatory.

Do Broad-Based Option Compensation Plans Improve Future Firm Performance for Technology and Non-Technology Firms?

We examine the relation between non-executive option compensation and future firm performance. As broad-based plans have become increasingly prevalent in the compensation landscape, our findings may help managers and shareholders evaluate the potential benefits of providing more inclusive option compensation plans. We also extend prior research linking executive option compensation to future firm performance by extending the definition of performance to include both earnings and cash flows. Our cash flow analyses provide support for other research linking option compensation to stock price and returns. Consistent with prior research, we find a positive payoff for executive options; one dollar of options granted to top executives leads to future operating income (cash flow) of $2.58 ($2.36). However, future operating income (cash flow) is only $0.40 ($1.15) for one dollar option value granted to non-executive employees suggesting that broad-based option compensation plans result in a negative or no payoff to shareholders, on average. We also provide evidence of that the payoff to option compensation differs in technology versus non-technology firms.

On the Timing of CEO Stock Option Awards

This study documents that the abnormal stock returns are negative before unscheduled executive option awards and positive afterward. The return pattern has intensified over time, suggesting that executives have gradually become more effective at timing awards to their advantage, and possibly explaining why the results in this study differ from those in past studies. Moreover, I document that the predicted returns are abnormally low before the awards and abnormally high afterward. Unless executives possess an extraordinary ability to forecast the future marketwide movements that drive these predicted returns, the results suggest that at least some of the awards are timed retroactively.

Governance and the Split of Options between Executive and Non-Executive Employees

We examine the determinants and consequences of the split of options between executive and non-executive employees. We find that the proportion of options granted to executives is lower the stronger is firm governance. For the sample as a whole, the relation between options and both operating income and valuation is weaker for executive options than for options to lower-level employees. Splitting the sample between weak and strong governance firms, for the weak (strong) governance firms, the relation between executive options and firm performance and valuation is weaker (stronger) relative to non-executive options. Results are robust to controls for the endogeneity of option granting choice. Taken as a whole, our results suggest that firms with relatively weak governance tend to give a larger proportion of options to executives and appear to receive relatively less benefit from those options.

Managerial Risk‐Taking Incentives and Executive Stock Option Repricing: A Study of US Casino Executives

I examine the relation between managerial incentives from holdings of company stock and options and stock option repricing. Because options provide incentives to increase both risk and stock price, firms must realize that as options go underwater, executives might face incentives to invest in risky, negative NPV projects. Repricing may alleviate such incentives. I examine repricing activity by firms in the US gaming industry and find that risk‐taking incentives from options are positively related to the incidence of executive option repricing. The results support the hypothesis that repricing assists firms in alleviating excessive risk‐taking incentives of senior management.

Do Managers Influence their Pay? Evidence from Stock Price Reversals Around Executive Option Grants

Using a database of 605,106 option grant filings by insiders between 1992 and 2002, we find significant abnormal stock return reversals around the grant date. Consistent with the hypothesis that managers influence their pay, the reversals are positively related to grant size and the seniority of the manager, and negatively related to the firm size. The reversals are also more pronounced for grants that are not awarded on a regular schedule. The returns following the grant date are negatively correlated to the returns prior to the grant date, indicating that some firms are attempting to influence the grant date stock price by more than just timing the grant date or timing information releases around the grant date. We find that the extent of reversals are positively related to the magnitude of the time interval between the grant date and the date the grants are reported to the SEC, suggesting that some firms are setting the grant date on a back-date basis, i.e., picking a date in the past with a lower stock price compared to that on the decision date.