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.

Subjective stock option values and exercise decisions : determinants and consistency

Stock option programs constitute an important economic domain both for the issuing companies and for their employees. Little is known, however, about which individual variables actually drive exercise patterns and how employees value their stock options. We study the following set of research questions to provide a contribution to a better understanding of these topics: How do employees exercise and value stock options? What are the determinants of exercise decisions and subjective option values? Do employees exercise options from different grants in a consistent way? Are subjective option values consistent with individuals' exercise decisions? We are able to use a unique data set combining employee-level option exercises with subjective option values extracted by means of an internal survey. Furthermore, we can combine this data with a wide set of individual variables. We find that employees exercise their stock options well before expiration. The median individual sacrifices more than 90% of the option's lifetime by exercising early. Surprisingly, we also find that individuals substantially overvalue the options they received. We show that exercise dates and option values are unrelated with measures of risk aversion. Loss aversion, however, does a better job in explaining the heterogeneity in option values. We also document that optimism and overconfidence measures are significantly related to option values. We show that managers that are very optimistic about company stock place higher values on their options. This finding is consistent with the sentiment hypothesis presented in Oyer and Schaefer (2004) and Bergman and Jenter (2004). Some evidence for an intertemporal consistency of exercises decisions is also provided. However, we find only weak support for the hypothesis that higher option values are associated with later exercise decisions

Indirect costs of financial distress and bankruptcy law: Evidence from trade credit and sales

We argue that stronger debt enforcement in bankruptcy can reduce indirect costs of financial distress: (i) by increasing the likelihood of restructuring outside bankruptcy and (ii) by improving the recovery rate of stakeholders, such as trade creditors, through explicit legal provisions. Consistent with these predictions, we find that when debt enforcement is stronger, financially distressed firms are less exposed to indirect distress costs in the form of reduced access to trade credit and forgone sales. We document these effects in a panel of firms from forty countries with heterogeneous debt enforcement characteristics and in differences-in-differences tests exploiting several recent bankruptcy reforms

Corporate governance and leverage: evidence from a natural experiment

We argue that the recent corporate governance reform in the Netherlands provides a natural experiment to explore the impact of changes in corporate governance on financing policy. We find that, relative to a control sample of comparable firms outside the Netherlands, Dutch firms significantly reduced their leverage following the passage of the reform. Our findings are consistent with the view that corporate governance improvements reduce the value of debt as a disciplining device

Did sox section 404 make firms less opaque? Evidence from cross-listed firms

We study whether Section 404 of the Sarbanes-Oxley Act of 2002 made cross-listed firms less opaque via an examination of analyst earnings forecasts. To test this, we compare European Union (EU) firms that are cross-listed in the US—and therefore subject to S404—with comparable EU firms that are not cross listed. We find that while both types of firms experienced a decrease in opaqueness over time, this decrease was significantly larger for cross-listed firms. Our results are robust to accounting for concurrent sell-side analyst regulations in the US, delistings, and changes in corporate risk taking. Overall, our analysis suggests that SOX had a positive effect on corporate disclosure quality

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

Managerial short-termism and investment: Evidence from accelerated option vesting

We show that executives cut investment when their incentives become more short term. We examine a unique event in which hundreds of firms eliminated option vesting periods to avoid a drop in income under accounting rule FAS 123-R. This event allowed executives to exercise options earlier and thus profit from boosting short-term performance. Our identification exploits that FAS 123-R’s adoption was staggered almost randomly by firms’ fiscal year-ends. CEOs cut investment and reported higher short-term earnings after option acceleration, and they subsequently increased equity sales

Opening the Black Box: Internal Capital Markets and Managerial Power

We analyze the internal capital markets of a multinational conglomerate to determine whether more powerful unit managers enjoy larger allocations. We use a new dataset of planned and actual allocations to business units to show that, although all unit managers systematically over-budget capital expenditures, more powerful and better connected managers obtain larger shares of cash windfalls and increase investment about 40% more than their less powerful peers. Results survive robustness tests and are not explained by differences in managerial abilities or an endogenous allocation of managers across units. Our findings support bargaining-power theories and provide direct evidence of a source of capital allocation frictions.Internal Capital Markets, Corporate Investment, Capital Budgeting, Managerial Power, Agency, Influence Activities, Corporate Politics