Corporate Governance and the Design of Stock Option Programs

Investors and academics increasingly criticize that features of employee stock option (ESO) programs reflect rent-extraction by managers (managerial power view). We use a unique European data set to investigate the relationship between the design of ESO programs and corporate governance structures. We find that ownership structures are related to the ESO design in a way that is consistent with the managerial power hypothesis: when ownership concentration is low and the exposition to the U.S. capital market is little, executives extract rents by designing poor ESO plans. Moreover, firms with weak creditor rights more often have badly designed option plans. Our findings also suggest that ineffective board structures (insider-dominated boards) are related to ESO design in a way that supports the arguments of the self-dealing view.

Influence of a fluorobenzene nucleobase analogue on the conformational flexibility of RNA studied by molecular dynamics simulations

Chemically modified bases are frequently used to stabilize nucleic acids, to study the driving forces for nucleic acid structure formation and to tune DNA and RNA hybridization conditions. In particular, fluorobenzene and fluorobenzimidazole base analogues can act as universal bases able to pair with any natural base and to stabilize RNA duplex formation. Although these base analogues are compatible with an A-form RNA geometry, little is known about the influence on the fine structure and conformational dynamics of RNA. In the present study, nano-second molecular dynamics (MD) simulations have been performed to characterize the dynamics of RNA duplexes containing a central 1'-deoxy-1'-(2,4-difluorophenyl)-ß-D-ribofuranose base pair or opposite to an adenine base. For comparison, RNA with a central uridine:adenine pair and a 1'-deoxy-1'-(phenyl)-ß-D-ribofuranose opposite to an adenine was also investigated. The MD simulations indicate a stable overall A-form geometry for the RNAs with base analogues. However, the presence of the base analogues caused a locally enhanced mobility of the central bases inducing mainly base pair shear and opening motions. No stable ‘base-paired’ geometry was found for the base analogue pair or the base analogue:adenine pairs, which explains in part the universal base character of these analogues. Instead, the conformational fluctuations of the base analogues lead to an enhanced accessibility of the bases in the major and minor grooves of the helix compared with a regular base pair

Cross-Sectional Aggregation and Persistence in Conditional Variance

This paper explores the interactions between cross-sectional aggregation and persistence of volatility shocks. We derive the ARMA-GARCH representation that linear aggregates of ARMA processes with GARCH errors admit, and establish conditions under which persistence in volatility of the aggregate series is higher than persistence in the volatility of the individual series. The practical implications of the results are illustrated empirically in the context of an option pricing exercise.ARMA process; Cross-sectional aggregation; GARCH process; Volatility persistence.

Contemporaneous-threshold smooth transition GARCH models

This paper proposes a contemporaneous-threshold smooth transition GARCH (or C-STGARCH)model for dynamic conditional heteroskedasticity. The C-STGARCH model is a generalization tosecond conditional moments of the contemporaneous smooth transition threshold autoregressive model of Dueker et al. (2007) in which the regime weights depend on the ex ante probability that a contemporaneous latent regime-specific variable exceeds a threshold value. A key feature of the C-STGARCH model is that its transition function depends on all the parameters of the model as well as on the data. The structural properties of the model are investigated, in addition to the finite-sample properties of the maximum likelihood estimator of its parameters. An application to U.S. stock returns illustrates the practical usefulness of the C-STGARCH model

A simple method for testing cointegration subject to regime changes

In this paper, we propose a simple method for testing cointegration in models that allow for multiple shifts in the long run relationship. The procedure consists of computing conventional residual-based tests with standardized residuals from Markov switching estimation. No new critical values are needed. An empirical application to the present value model of stock prices is presented, complemented by a small Monte Carlo experiment.Cointegration; Markov Switching; Standardized residuals.

Residual-based tests for cointegration and multiple regime shifts

In this paper we examine the properties of several cointegration tests when long run parameters are subject to multiple shifts, resorting to Monte Carlo methods. We assume that the changes in cointegration regimes are governed by a unobserved Markov chain process. This specification has the considerable advantage of allowing for an unspecified number of stochastic breaks, unlike previous works that consider a single, deterministic break. Our Monte Carlo analysis reveals that testing cointegration with the usual procedures is a quite unreliable task, since the performance of the tests is poor for a number of plausible regime shifts parameterizations.Cointegration; Tests; Structural change; Markov Switching; Monte Carlo

Stock Options and Employee Behavior

Employee stock options (ESOs) are a widespread and economically highly significant phenomenon, both at the company and at the employee level. Stock options are not only relevant for CEOs, but also and increasingly for managers at lower grades in a corporation. Despite its economic importance, there exists very little empirical research that examines the behavior of employees in stock option programs. Our study attempts to fill this gap by empirically studying the behavior of option holders in a distinct ESO plan. We try to answer the following questions: How do employees exercise their stock options? How do employees dispose of company stock acquired in stock option programs? What rational and behavioral factors explain differences in observed exercise behavior? We study these questions by combining two data sets. The first data set consists of detailed individual-level ESO exercise transactions of senior managers from a large German corporation (transaction data). The second data set is based on an extensive questionnaire in which we asked these employees to answer a wide range of questions on employee-specific characteristics, beliefs and attitudes (questionnaire data). We find that employees exercise their options very early and in a few large transactions. A large majority of option recipients sell the shares acquired on exercise. Furthermore, our results suggest that, inconsistent with traditional ESO theories, exercise behavior is not driven by factors like risk aversion or individuals' holdings of company stock that are included in rational models of exercise. Our findings suggest that individuals' exercise decisions depend on the psychological factors miscalibration and mental accounting

What Determines How Top Managers Value their Stock Options?

What determines how top managers value their executive stock options? We explore this question empirically by using a unique survey data set which combines subjective option valuation data with a wide set of individual-level variables. Inconsistent with the predictions of theory, individuals in our data set substantially overvalue the options they receive. Optimism and overconfidence (miscalibration) measures are significantly related to option values, whilst measures of risk aversion show no relationship. When managers are very optimistic about company stock they attribute higher values to their options. This finding is consistent with the implicit assumption in Malmendier and Tate (2005, 2007) and Malmendier et al. (2007). These papers assume that managers who overestimate future stock prices value their options higher and exercise at later points. We also find that less overconfident (miscalibrated) managers put higher values on their options

Corporate governance and the design of stock option programs

Investors and academics increasingly criticize that various design features of executive stock option (ESO) plans reflect self-dealing by managers and the inability of corporate governance mechanisms in monitoring executives (managerial power hypothesis). We use a unique and not publicly available data set to investigate design features of ESO programs. The companies in our sample show a very large variation with respect to the characteristics of their ESO plans (e.g. in the use of relative performance targets that need to be met before options become exercisable). We study the relationship between the design of ESO plans and corporate governance structures to test the managerial power hypothesis. We document that when governance structures are weak, option plans are designed in a way desired by managers. When ownership concentration is low, firms more often have ESO plans that are favorable to executives. We also find that firms with fewer outside board members and weaker creditor rights more often have option plans that are favorable to managers. Favorable ESO plans usually coincide with large option packages