Option Wealth Research Articles

CEO Current Option Wealth at Risk and Lobbying Breadth: A Behavioral Agency Perspective

CEO Current Option Wealth at Risk and Lobbying Breadth: A Behavioral Agency Perspective

Behavioral Agency Model and Corporate Social Irresponsibility: Uncovering the Implication of Fairness in CEO Compensation

Behavioral agency model (BAM) posits that executive risk preferences are influenced by losses to their current option wealth relative to gains from their prospective option wealth. Accordingly, current option wealth attenuates risk-taking while prospective option wealth amplifies risk-taking. In the context of corporate irresponsible behaviors, this study attempts to advance the BAM by theorizing how the presence of conditions that give rise to distributive and procedural injustice in CEO compensation can further amplify the positive effects of CEO prospective option wealth on risk-taking, thereby destroying stakeholder value. Our findings, based on a longitudinal cross-sectional sample of 8,669 firm-year observations for the period 2001 to 2018, support our theorization that CEO perceptions of unfairness in compensation amplify excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. Our study has important implications for advancing the BAM and for the study and design of executive compensation.

Behavioural Agency and Firm Productivity: Revisiting the Incentive Alignment Qualities of Stock Options

AbstractDrawing on behavioural agency theory, we revisit the incentive alignment qualities of stock options. Using behavioural agency’s logic, we theorize that chief executive officers (CEOs) are likely to perceive efforts directed at firm productivity as a means of protecting their option wealth (the value of previously awarded stock options). Our reasoning suggests that CEO option wealth positively influences firm productivity and that productivity mediates the relationship between CEO option wealth and firm value. Our theory also points to boundary conditions at the CEO level and the firm level. Our study advances research on the utility of stock options by focusing on effort and productivity as the mechanism through which option incentives affect CEO behaviours. We demonstrate that option risk bearing can align CEO–shareholder interests.

Stakeholder Agency Relationships: CEO Stock Options and Corporate Tax Avoidance

AbstractInfusing stakeholder agency theory with insights from behavioural agency theory, we describe a frame‐dependent relationship between CEO stock option incentives and tax avoidance. Our theoretical framework highlights the role of competing shareholder demands in providing a salient reference point for a CEO contemplating the implications of tax avoidance for their stock option wealth. In a study of 2,573 publicly listed U.S. firms between 1993 and 2014, we show that the implications of CEO stock option incentives are contingent on whether the firm’s effective tax rate is anticipated to be below or above the tax rate of peer firms – an outcome that the CEO can cast as balancing stakeholder demands. Consistent with our theoretical reasoning, we also show that, both above and below this reference point, the implications of option incentives for corporate tax avoidance are amplified by the level of activist institutional ownership and attenuated by the CEO’s ability to unwind their bond with shareholders through hedging. In doing so, our study offers an impetus for a broader stakeholder approach to governance research examining CEO incentive alignment.

Me First? Behavioral Agency and CEO Opportunism in Faulty Product Recalls

Stock options have been widely used to align the interests of executives and shareholders. By integrating theories of attention with the behavioral agency model, we offer a framework that predicts opportunistic CEO responses to option incentives that affect firm customers. We argue that CEOs will preserve their option wealth through their timing of product recalls. Specifically, during a fiscal year, CEOs announce product recalls during periods of market inattention to reduce loss or, during high attention fiscal year-end period, may postpone product recalls to delay loss. Such delays and evasions can harm customers both financially and physically. Using a sample from U.S. public medical device producers that made product recalls during 2004–2017, we confirm our hypotheses. Our findings give boards of medical device firms behavioral levers to protect users and the firm’s future.

Behavioral agency and corporate entrepreneurship: CEO equity incentives & competitive behavior

Scholars have long studied drivers of entrepreneurial behavior among established firms. Yet little is known about how individual factors shape a firm’s choice to pursue entrepreneurship. We draw on behavioral agency theory to explore the role of equity incentives in driving corporate entrepreneurship. Our findings suggest CEOs avoid corporate entrepreneurial behaviors as their option wealth increases. However industry dynamics also prove to be an important contingency when predicting the effects of both restricted stock and stock options on the likelihood that the CEO engages in corporate entrepreneurship. Our findings provide a theoretical platform for predicting dimensions of entrepreneurial behavior and highlight effects of CEO equity ownership.

The Ethical Dimension of Equity Incentives: A Behavioral Agency Examination of Executive Compensation and Pension Funding

We draw on the behavioral agency model to explore the ethical consequences of CEO equity incentives. We argue that CEOs are more concerned with funding pension plans when they have more to gain from their stock options yet will increasingly underfund employee pension funds as their current option wealth increases. Our findings reveal that both effects hold when the CEO has greater power (also occupying board chair) over firm decision making. Our study suggests that there is an ethical dimension to equity incentives, given they are intended to align CEO interests with shareholders, yet potentially incentivize CEO behaviors with adverse consequences for employees. Insights from our findings provide boards and regulators with behavioral levers to protect employee well-being in the context of pension funding.

CEO equity risk bearing and strategic risk taking: The moderating effect of CEO personality

Research SummaryWe draw upon applied psychology literature to explore interagent differences in perceived risk to their equity when making strategic risk decisions. Our theory suggests behavioral agency's predicted negative relationship between equity risk bearing and strategic risk taking is contingent upon four personality traits. Our empirical analyses, based on personality profiles of 158 Chief Executive Officers (CEOs) of S&P 1,500 firms in manufacturing industries, indicate the relationship between executive risk bearing and strategic risk taking crosses from negative to positive for high extraversion, greater openness, and low conscientiousness. These findings demonstrate that agency based predictions of CEO risk taking in response to compensation—and board attempts at creating incentive alignment using compensation—are enhanced by integrating insights from personality trait literature.Managerial SummaryWe study the effect of CEO personality on their behavioral responses to stock option pay. Our findings reveal that CEOs that score high on extraversion or openness and low on conscientiousness are less likely to decrease their firm's strategic risk taking as the value of their stock options increases. That is, the tendency of CEOs to become more risk averse in their strategic choices as their option wealth increases (due to loss aversion) is weaker for highly extraverted and more open CEOs, but stronger for more conscientiousness CEOs. Overall, our findings suggest that board of directors need to consider personality traits of their CEOs when designing compensation packages with the intention to align incentives of CEOs with shareholder risk preferences.

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.

CEO option wealth and firm risk-taking: An analysis of multiple reference points

The behavioral agency literature focusing on how CEO stock option gains impact risk taking generates mixed findings, showing positive effect in some studies and negative effect in others. We reconcile this equivocality by introducing the pay reference point which delineates CEO options into both negative and positive deviation contexts. Building on the behavioral agency model and the myopic loss aversion concept derived from the theory of intertemporal preferences we conceptualize how pay reference points of CEO current and future option wealth directly affect risk taking and how bankruptcy likelihood and slack moderate this relationship. We suggest risk taking increases when both option wealth types are in a negative deviation context because CEOs strive to improve performance. In a positive deviation context, current wealth reduces risk taking as CEOs seek to protect their options but future wealth increases risk taking due to a longer option payoff horizon. For CEOs holding current and future option wealth, we argue bankruptcy likelihood weakens and amplifies risk taking respectively in the negative deviation context while slack facilitates risk taking in the positive deviation context. Empirical testing using a manufacturing panel dataset largely supports our hypotheses.

Going short-term or long-term? CEO stock options and temporal orientation in the presence of slack

Research summary: We draw on behavioral agency theory to explain how decision heuristics associated with CEO stock options interact with firm slack to shape the CEO's preference for short- or long-term strategies (temporal orientation). Our findings suggest CEO current option wealth substitutes for the influence of slack resources in encouraging a long-term orientation, while prospective option wealth enhances the positive effect of slack on temporal orientation. Our theory offers explanations for non-findings in previous analysis of the relationship between CEO equity based pay and temporal orientation and provides the insights that CEO incentives created by stock options (1) enhance the effect of available slack upon temporal orientation and (2) can both incentivize and de-incentivize destructive short-termism, depending upon the values of current and prospective option wealth. Managerial summary: We explore how compensation design can play a role in affecting the CEO's preference for short- or long-term strategic projects. When the CEOs have accumulated option wealth, they are more likely to invest in the long term. Yet when they have a large number of recently granted options with the potential to generate significant wealth in the event of successful risk taking, the CEO is more likely to prefer the short term in order to achieve personal wealth gains more quickly. The more liquid assets the firm holds, the weaker both of the aforementioned effects. An implication for boards is that they should anticipate CEO short-termism if the CEO has been granted new options, underlining the potential negative consequences of option compensation. Copyright © 2015 John Wiley & Sons, Ltd.

"CEO Risk Taking in Family Firms: The Behavioral Agency Model, Family Control and CEO Option Wealth"

We apply the behavioral agency model (BAM) and the concept of mixed gambles to analyze the inter-play between the managerial agent (CEO) and family principals as precursors of firm risk taking. Our findings suggest that the CEOs’ attempts to preserve their (current) option wealth or pursue additional (prospective) wealth through risky strategic choices will be constrained by the family principal’s desire to maintain control over the firm’s strategic decisions. We draw upon theory of social exchange to argue that long tenured CEOs are more likely to coalesce with family goals as opposed to pursuing their own opportunistic agenda. Finally, we demonstrate that firm size attenuates the socioemotional impact upon family firm motivation for inter-generational control. Our study enhances knowledge regarding the unique nature of agency problems within family firms and refines the BAM’s formulation by demonstrating the role of ownership structure in frameworks predicting agent risk taking.

CEO Option Wealth and Firm Risk-Taking: An Analysis of Multiple Reference Points

The behavioral agency model suggests CEO current wealth affects firm risk-taking. Extending this theory we explore how reference points of CEO current and future wealth (as reflected in respective ...

A few bad apples: An analysis of CEO performance pay and firm productivity

We investigate the relationship between CEO performance pay incentives and firm productivity. In general, we find an inverse U-shaped relationship between productivity and the sensitivity of CEO wealth to share value ( delta) and a positive relationship between productivity and the sensitivity of CEO option wealth to stock return volatility ( vega). Thus, a high delta associated with CEO risk-aversion lowers productivity, but a high vega from stock options offsets this effect. In looking at delta and vega jointly, we also find that options do not always achieve their intended purpose. These results are stronger among firms that are weakly governed or when high transaction costs prevent the writing of an optimal compensation contract.

CEO Incentives and Firm Productivity

This paper investigates the relationship between firm productivity and CEO performance incentives in a sample of 917 U.S. manufacturing firms during the period 1992-2003. We first find that CEO equity ownership enhances firm productivity and that firm productivity enhances corporate financial performance. We then find that the relationship between CEO performance incentives and productivity is quite complex. There is an inverse U-shaped relationship between productivity and the sensitivity of CEO wealth to share value (delta), which suggests that the high CEO portfolio risk associated with high delta discourages CEOs from undertaking risky positive-NPV, productivity-enhancing projects. We also find that greater sensitivity of CEO option wealth to stock return volatility (vega) generally increases firm productivity, consistent with stock option grants making CEOs less concerned with risk due to the down-side protection it offers. However, for a range of delta values, higher vega may actually reduce productivity, a result that has not been previously documented empirically. This suggests that stock options may not always achieve their intended effect of making CEOs less risk-averse. These results highlight the importance of careful structuring of CEO compensation contracts. Encouragingly, we find that CEO performance incentives positively impact productivity for the vast majority of the firms in our sample.

Option Wealth and Bequest Values: The Value of Protecting Future Generations from the Health Risks of Nuclear Waste Storage

<h3>SUMMARY</h3> The plant extracellular space, including the apoplast and plasma membrane, is the initial site of plant– pathogen interactions. Pathogens deliver numerous secreted proteins, called effectors, into this region to suppress plant immunity and establish infection. Downy mildew caused by the oomycete pathogen <i>Sclerospora graminicola</i> (Sg) is an economically important disease of Poaceae crops including foxtail millet (<i>Setaria italica</i>). We previously reported the genome sequence of Sg and showed that the Jacalin-related lectin (JRL) gene family has significantly expanded in this lineage. However, the biological functions of JRL proteins remained unknown. Here, we show that JRL from <i>S. graminicola</i> (SgJRL) functions as an apoplastic virulence effector. We identified eight SgJRLs <i>via</i> protein mass spectrometry analysis of extracellular fluid from <i>S. graminicola</i>-inoculated foxtail millet leaves. SgJRLs consist of a Jacalin-like lectin domain and an N-terminal putative secretion signal, and <i>SgJRL</i> expression is induced by Sg infection. Heterologous expression of three SgJRLs with N-terminal secretion signal peptides in <i>Nicotiana benthamiana</i> enhanced the virulence of the pathogen <i>Phytophthora palmivora</i> inoculated onto the same leaves. Of the three SgJRLs, SG06536 fused with GFP localized to the apoplastic space in <i>N. benthamiana</i> leaves. INF1-mediated induction of defense-related genes was suppressed by co-expression of SG06536-GFP. These findings suggest that JRLs are novel apoplastic effectors that contribute to pathogenicity by suppressing plant defense responses.

Too much of a good incentive? The case of executive stock options

Using a utility-maximization framework, I show that the incentive to increase stock price does not always increase as more options are granted. Keeping the total cost of his compensation fixed, granting more options creates greater incentives to increase stock price only if option wealth does not exceed a certain fraction of total wealth. Beyond this critical level, granting more options actually reduces incentive effects and becomes counterproductive. In addition, stock options also create incentive to reduce (increase) idiosyncratic (systematic) risk. These incentive effects are sensitive to the choice of exercise price.

CEO compensation, option incentives, and information disclosure

AbstractThis paper examines the impact of information disclosure on the valuation of CEO options and the incentives created by those options. Prior executive compensation research in the US has made assumptions about key input variables that can affect the calculation of option values and financial incentives. Accordingly, biases may have ensued due to incomplete information disclosure about noncurrent option grants. Using new data on a sample of UK CEOs, we value executive option holdings and incentives for the first time and estimate the levels of distortion created by the less than complete US‐style disclosure requirements. We also investigate the levels of distortion in the UK for the minority of companies that choose to reveal only partial information. Our results suggest that there have to date been few economic biases arising from less than complete information disclosure. Furthermore, we demonstrate that researchers using US data, who made reasonable assumptions about the inputs of noncurrent option grants, are unlikely to have made significant errors when calculating CEO financial incentives or option wealth. However, the recent downturn in the US stock market could result in the same assumptions, producing exaggerated incentive estimates in the future.

Relative performance evaluation in CEO pay contracts: evidence from the commercial banking industry

Reviews previous research on the effects of CEO compensation structure, outlines the criteria for relative performance evaluation (RPE) and notes the paucity of empirical evidence to support it. Reports a study of the use of RPE for US bank CEO compensation 1976‐1988; and its relationship to shareholder, market and industry returns. Explains the methodology and presents the results, which suggest that CEO pay is positively linked to firm performance, but negatively linked to market/industry performance; and that performance is positively linked to CEO option wealth. Adds that both the pay/performance link and the use of RPE increased after bank deregulation in the early 1980s. Considers consistency with other research and concludes that the reduction in compensation risk offered by RPE should reduce compensation cost and thus provide a good reason for the banking industry to increase its use.