Firms Grant Research Articles

Impacts of CEO Incentives and Power on Employee Wages

Purpose - This study investigates the impact of CEO incentive compensation and power on employee wages. While CEO compensation negatively affects employee wages, powerful CEOs may care for employees, and their compensation can have positive impacts on employee wages.
 Design/Methodology/Approach - Using data from US capital markets during 1992 - 2017, we employ pay-performance sensitivity to measure incentive compensation and CEO pay slices to proxy CEO power. We also examined the potential interaction effects between CEO compensation and CEO power. We conduct a Heckman two-step analysis to address potential sample bias and two-stage regression to address potential endogeneity.
 Findings - While incentive compensation negatively affects employee wages, CEO power positively affects employee wages. When examining the interaction effect between incentive compensation and CEO power, we note that the incentive effect is negative on employee wages only when the CEO is less powerful. However, when the CEO is more powerful, the incentive effect is positive on employee wages.
 Research Implications - When firms grant incentive compensation to CEOs for firm performance, they must also consider CEO power. Our results imply that CEO incentive compensation has a positive impact on employee wages when a CEO becomes more powerful. More incentive compensation to less-powerful CEOs could suppress employee wages and hurt firm performance in the long run.

Inter-corporate loans: the Indian experience

ABSTRACTWe examine transactions of inter-corporate loans among Indian non-financial firms during 1999–2014. We find that the consolidated amount of these loans is not small and comparable to total short-term bank loans transacted in a year. Over the years, a number of such loan providers/receivers has increased. Both group and stand-alone firms across different industries receive and provide inter-corporate loans and these transactions are not one-off events. Larger and older firms grant these loans to smaller and younger firms. Loan receivers report higher leverage, accounts payable and lower cash balance than non-receivers and about thirty percent of loan receivers are financially distressed.

Local Employment Opportunities and Corporate Retention Policies

We study how firms adjust their corporate retention policies to their employees’ local job opportunities. The more similarities between the firm’s labor-skill profile and the local labor market’s—a measure we label LEO—the greater are the employees’ outside options. We show that, when LEO is high, firms grant more rank-and-file stock options, provide a more employee-friendly work environment, and maintain higher financial flexibility. The relation between LEO and retention policies is stronger for firms with high-skill workers and high R&D. Two quasi-natural experiments, the staggered adoption of the Inevitable Disclosure Doctrine and Hurricane Katrina, support a causal relation.

Regulating Cancellation Rights with Consumer Experimentation

Embedding consumer experimentation with a product or service into a market environment, we find that unregulated contracts induce too few returns or cancellations, as they do not internalize a pecuniary externality on other firms in the market. Forcing firms to let consumers learn longer by imposing a commonly observed statutory minimum cancellation or refund period is socially efficient only when firms appropriate much of the market surplus, while it backfires otherwise. Interestingly, cancellation rights are a poor predictor of competition, as in the unregulated outcome firms grant particularly generous rights when competition is neither too low nor too high.

Rank and file employees and the discovery of misreporting: The role of stock options

We find that firms grant more rank and file stock options when involved in financial reporting violations, consistent with managements’ incentives to discourage employee whistle-blowing. Violating firms grant more rank and file options during periods of misreporting relative to control firms and to their own option grants in non-violation years. Moreover, misreporting firms that grant more rank and file options during violation years are more likely to avoid whistle-blowing allegations. Although the Dodd-Frank Act (2010) offers financial rewards to encourage whistle-blowing, our findings suggest that firms discourage whistle-blowing by giving employees incentives to remain quiet about financial irregularities.

Overcoming localization of knowledge - the role of professional service firms

The literature on organizational learning asserts that external learning is often limited geographically and technologically. We scrutinize to what extent organizations acquire external knowledge by accessing external knowledge repositories. We argue that professional service firms (PSFs) grant access to nonlocalized knowledge repositories and thereby not only facilitate external learning but also help to overcome localization. Focusing on patent law firms, we test our predictions using a unique dataset of 544,820 pairs of European patent applications. Analyzing patterns of knowledge flows captured in patent citations, we find that accessing a PSF's repository facilitates the acquisition of external knowledge. As the effect is more pronounced for knowledge that is distant to a focal organization, we conclude that having access to a knowledge repository compensates for localization disadvantages. Copyright © 2013 John Wiley & Sons, Ltd.

Executive stock options: a panel data analysis of determinants in Portugal

This study investigates the determinants of stock options grants to CEOs by Portuguese firms from 2003 to 2006. Using a sample of 155 observations, we find that the CEO’s equity ownership, liquidity constraints, board composition and firm size significantly increase the probability that firms grant stock options, whereas board size, firm risk and investment opportunities significantly decrease the likelihood of such stock options attribution. Our results contribute to the existing debate on the appropriate compensation contract. In addition, this study provides evidence that agency theory also explains the decisions about stock options grants in countries like Portugal, which presents a corporate governance structure characterised by concentrated firm ownership and a strong bank presence.

DO NON-COMPETITION AGREEMENTS LEAD FIRMS TO PURSUE PATH-BREAKING INVENTIONS?

Non-competition agreements are contracts signed by employees and firms that prohibit employees from joining or forming a rival company after splitting from the firm. Stricter enforcement of such contracts may induce firms to undertake riskier R&D projects, leading to technological breakthroughs or dead ends. Specifically, non-competition agreements reduce the risk that the firm loses the fruits of inventive activity by its employees, such that when the enforcement of non-compete covenants is stricter, firms grant corporate inventors more freedom to explore risky but high-potential research paths. This study uses data about U.S. patent applications between 1990 and 2000 to identify the impact of non-competition agreements and considers both cross-state and longitudinal variation in the enforcement of non-compete clauses. The empirical findings are mainly consistent with theory and show that in states with stricter enforcement, companies are more likely to undertake risky and potentially path-breaking R&D projects than in states that do not enforce non-compete agreements as strictly.

The relation between corporate governance and CEOs’ equity grants

We investigate whether the firm’s corporate governance affects the value of equity grants for its CEO. Consistent with the managerial power view, we find that more poorly-governed firms grant higher values of stock options and restricted stock to their CEOs after controlling for the economic determinants of these grants. We show that the negative relation between governance strength and equity grants is not likely to be attributable to omitted economic factors or substitution effects between governance strength and equity incentives. As further evidence consistent with the managerial power view, we show that firms with poorer governance in the pre-Enron era cut back more on using employee stock options (ESOs) for their CEOs in the post-Enron era, a period when the accounting and outrage costs of ESOs increased, consistent with poorly-governed firms taking more advantage of opaque ESO accounting rules than better-governed firms. We show that the association between governance strength and abnormal equity grants is less negative in the post-Enron period than it was in the pre-Enron period, consistent with firms making more efficient equity-granting decisions after the corporate governance changes mandated by the Sarbanes–Oxley Act of 2002 and the major US stock exchanges took effect.

Why Firms Award Stock Options -- Examining the Design of Employee Stock Options

This study explores whether firms grant employee stock options to motivate and retain employees by examining the determinants of the use of option grants and how firms design vesting and maturity restriction terms. The results show that there is a relationship between the granting of stock options and the retaining of employees and motivating long-term profit-maximizing behavior. This study also finds that a firm sets more rigorous restrictions on exercising options when retaining employees is a high priority for a firm. The results suggest that firms not only grant stock options to provide performance and retention incentives for employees, but also amplify the effects of incentives by fine-tuning the rules governing the exercising of option grants.

Separating Pro-Competitive from Anti-Competitive Loyalty Rebates: A Conceptual Framework

Separating Pro-Competitive from Anti-Competitive Loyalty Rebates: A Conceptual Framework

Give everyone a prize? Employee stock options in private venture-backed firms

This study examines employee stock options in private entrepreneurial companies. I focus on private U.S. venture-backed firms because they are renowned for the intensity and organizational depth of their stock option grants. Contrary to simple stereotype, however, I show that 27% of U.S. venture-backed firms do not grant stock options to all employees. I seek to explain this by theorizing that the economic and legal settings in which venture-backed companies exist lead to both costs and benefits from the use of stock options to attract, compensate, incent, monitor, and retain certain employees, and that sometimes the costs exceed the benefits. I test the theory by determining whether variation in the organizational depth to which venture-backed firms grant employee stock options can be explained by proxies for these economic and legal costs. Such proxies include the fraction of employees who are in technical positions; the degree of flatness in the firm's organizational structure; its proximity to other venture-backed companies; the number of patents it has been granted; and the fraction of equity held by venture investors. The results support the theory and thereby imply that venture-backed firms grant employee stock options in an economically sophisticated manner.

Stock and Option Grants with Performance-Based Vesting Provisions

While existing literature on equity-based compensation is focused heavily on stock option and restricted stock awards that carry simple time-based vesting restrictions, we find that more complicated performance-based vesting provisions are quite common. We construct and analyze a novel dataset containing 1,013 equity-based awards with performance-vesting features granted by U.S. firms during the period 1995 through 2001. We examine the characteristics of these compensation plans, the economic rationale for adoption, the valuation and incentive effects of these awards, and the effect of the plan adoptions on managerial behavior. First, we find that these awards either (i) require achievement of specific stock market and accounting targets in order to vest or (ii) have a payout and vesting schedule that depends on performance of the firm relative to peers or an index. These performance-vesting conditions are based primarily on either accounting performance or stock market performance, but there is significant variation in plan design. Second, we find evidence that firms grant these equity awards to increase managerial incentives and also may use these awards as a sorting mechanism for managerial talent. For example, these awards are more likely to be adopted following poor performance and when the firm hires a new CEO. Third, we find that the pay-for-performance sensitivities associated with these awards are economically significant and are higher among firms with poorer prior performance and lower overall levels of prior investment expenditures. Both results suggest that firms design these awards to increase incentives. Finally, we find an increase in investment activity and improved firm performance subsequent to the adoption of these plans.

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.

Financial Reporting Concerns, Framing Effects and Employee Stock Option Grants

Managers are concerned about reported earnings (e.g., Graham et al. 2005). The favorable accounting treatment for employee stock options (ESO) available under the pre-expensing regime lead managers to frame ESOs as cheap to grant (e.g., Murphy 2002 2003; Hall and Murphy 2003; Jensen and Murphy 2004). This paper tests two effects of framing in the context of employee stock option grants: the reference-point-dependent preferences and the ratio-difference principle. I analyze stock option grants to CEOs, the other top 4 executives, and non-executive employees in 859 firms from 1996 to 2002. I find that firms grant more stock options when doing so helps them to meet or beat earnings targets, consistent with the notion of reference-point-dependent preferences in prospect theory. Further, I analyze the relationship between the extent of potential expense saving and stock option grants. I find that firms grant more options when granting stock options have a bigger impact on reported earnings, consistent with the ratio-difference principle in mental accounting theory. In sum, results suggest that management decision making of ESO grant is subject to framing effects.

Investor myopia and CEO compensation

We examine the impact of investor horizon on the design of compensation contracts. Using a sample of IPO firms, we contrast long-term incentives provided to CEOs across firms with venture capital (VC) investors who are myopic and other firms where shareholders have relatively longer investment horizons. We construct several new measures of long-term incentives that capture the horizon of the compensation. We find that VC-backed firms reduce long-term incentives when the lockup expires whereas non-VC-backed firms increase their long-term incentives to mitigate the high level of managerial myopia in the period following the IPO. Specifically VC backed firms grant a greater proportion of annual compensation in the form of cash and vested equity-based compensation, the duration of the compensation is lower, and the proportion of vested options to total option holdings is higher in the lockup expiration year. We also explore the long-run consequences of myopic contracts. We find that the long-run (short-run) stock performance is lower (higher) when contracts are myopic consistent with myopic managers maximizing short run performance at the cost of long run performance.

Granting non‐tradable stock options: the opportunity costs for shareholders and employees

Purpose – Firms grant non‐tradable stock options to their employees as an incentive device. Is the cost of issuing these options equal to the amount the company would receive if it sold the same options to outside investors? The evaluation of this cost is the main objective of this article. The options granted to employees are not tradable, due to the incentive scheme to which they are related. A non‐tradable option is an asset that cannot be evaluated with standard Black‐Scholes formulas.Design/methodology/approach – The article adopts standard option pricing, introducing some corrections since Black‐Scholes formulae do not apply. The new formulae show the dependence of option values on how diversified both the employees and the firm are; and the influence that the incentive to work by employees has on the stock price.Findings – Once stock options satisfy a participation constraint, they can be granted to employees who stand to gain. However, they do not provide a net benefit in all circumstances to shar...

Executive stock options and incentive effects due to systematic risk

Existing research on executive stock options mainly focuses on total risk when studying risk incentives. In this study, we use a GARCH option pricing framework to show that the incentive effects of executive stock options depend on the composition of risk. Controlling for total risk, the value of executive stock options increases with systematic risk and this effect is stronger when the total risk is low. Thus, when firms grant standard or non-indexed options, CEOs will have incentives to increase systematic risk even when the total risk remains constant. In contrast, indexed options will provide CEOs with incentives to reduce systematic risk. We therefore conclude that an optimal mix of indexed and non-indexed option grants will provide CEOs with incentives to take the desired level of systematic risk.

Executive Option Repricing, Incentives, and Retention

ABSTRACTWhile many firms grant executive stock options that can be repriced, other firms systematically restrict or prohibit repricing. This article investigates the determinants of firms' repricing policies and the consequences of such policies for executive turnover and retention. Firms that have better internal governance, that use more powerful stock‐based incentives, or that face less shareholder scrutiny are more likely to maintain repricing flexibility. Firms that restrict repricing are more vulnerable to voluntary executive turnover following stock price declines. When share price declines are severe, restricting firms appear to award unusually large numbers of new options.

RISK-AVERSE EXECUTIVES, MULTIPLE COMMON RISKS, AND THE EFFICIENCY AND INCENTIVES OF INDEXED EXECUTIVE STOCK OPTIONS

We extend research on executive stock options in two ways. First, we generalize Johnson and Tian's (Journal of Financial Economics, 57 (2000b)) single indexed executive stock option to incorporate multiple common risks. Second, we use an expected utility framework to analyze the efficiency and incentive effects of traditional and indexed option grants for risk-averse executives. If firms grant equal numbers of each option type and adjust their moneyness to provide equal utility to executives, single and multi-indexed option grants are less expensive than traditional options while providing stronger incentives to increase stock price. If firms adjust the number of options granted instead of their moneyness to produce equal utility, indexed option grants are more expensive than traditional grants. For firms facing multiple common risks, multi-indexed options are less expensive and provide stronger incentives to increase stock price than single indexed options.