Replacing executive stock options with share units: A Canadian study

Are share units a better compensation tool than stock options? This paper studies the impact of a transition within the compensation structures of CEOs of companies listed on the TSX Composite Index. Specifically, we ask whether replacing options with units-based compensation reduces the volatility of these companies' stock prices while promoting better returns. Our findings show that a shift to share units reduces large-cap Canadian companies' total risk through its idiosyncratic component. This transition is also accompanied by an increase in their risk-adjusted accounting and market performance. This suggests that share units are better for compensation contracts.     

ACCOUNTING FOR RISK AVERSION, VESTING, JOB TERMINATION RISK AND MULTIPLE EXERCISES IN VALUATION OF EMPLOYEE STOCK OPTIONS

We present a valuation framework that captures the main characteristics of employee stock options (ESOs), which financial regulations now require to be expensed in firms' accounting statements. The value of these options is much less than Black–Scholes prices for corresponding market-traded options due to the suboptimal exercising strategies of the holders, which arise from risk aversion, trading and hedging constraints, and job termination risk. We analyze the combined effect of all of these factors along with the standard ESO features of multiple exercising rights, and vesting periods. This leads to the study of a chain of nonlinear free-boundary problems of reaction-diffusion type. We find that job termination risk, vesting, finite maturity and non-zero interest rates are significant contributors to the ESO cost. However, we find that in the presence of vesting, the impact of allowing multiple exercise rights on ESO cost is negligible.     

Customer satisfaction underappreciation: The relation of customer satisfaction to CEO compensation

Customer satisfaction contributes to firm financial performance, but does it contribute to top executives' pay? Our empirical evidence shows that it may not. Customer-satisfying executives tend to have lower pay than their productive peers, even if both satisfaction and productivity contribute to firm financial performance. Thus, customer satisfaction is underappreciated, which may result in both less societal welfare and worse company performance. We propose a board myopia mechanism to account for this phenomenon. In facing short-term financial performance pressure from investors, and the asymmetric information availability between accounting-based and market-based assets for compensation decisions, the board of directors may be myopic, underappreciating executives who invest in market-based assets such as customer satisfaction that drive long-term returns. We examine this satisfaction underappreciation phenomenon empirically using 23 years of panel data that detail firm productivity, customer satisfaction, firm financial performance, and executive compensation. The longitudinal data are analyzed using fixed-effect panel models and a simultaneous system of panel vector autoregression equations with interactions to assess the direct effect of firm financial performance and its carryover effect to executive compensation across executives who are productive, customer-satisfying, or both. The results confirm that customer-satisfying executives are underappreciated: being productive is financially rewarding for both firms and executives, while being customer-satisfying is financially rewarding for firms but not as much for executives. We further demonstrate that using total shareholder returns to benchmark firm financial performance and reward executives with a higher proportion of stock compensation can encourage a long-term focus that alleviates this customer underappreciation.     

Linking new product alliances to stock returns and risk

Although firms widely engage in new product alliances, prior research has paid limited attention to their financial impact, especially, both stock returns and risk. In addition to the direct impact of product alliances, I have assessed how firm and alliance characteristics can moderate such effects. I have examined firm size and alliance type as moderators to the product alliance and stock performance relationship. Using a large database of 506 firms and 3714 new product alliances over 21 years, I estimate a random effects model. My findings are that new product alliances demonstrate an increase in stock returns and a decrease in stock risk. In addition, these effects are heterogeneous across firm size and alliance type. This research has implications for both new product alliances and marketing-finance interface literature.     

How Do Franchise Ownership Structure and Strategic Investment Emphasis Influence Stock Returns and Risks?

Franchisors seek to maximize firm value by managing investments both in tangible and intangible assets and in the mix of company and franchised outlets, yet little is known about how investors respond to shifts in these strategic decisions. Our goal is to assess the impact of these decisions on shareholder value within franchise systems through panel-data models. Specifically, we provide evidence on how investors in publicly traded franchises evaluate both the ownership structure and the strategic investment emphasis between intangible assets (e.g., brand) and tangible assets (e.g., plant and property). We find that an increase in the proportion of franchised units is negatively associated both with stock returns and idiosyncratic risk. In contrast, an increase in the emphasis on strategic investments in intangible assets is positively associated both with stock returns and idiosyncratic risk. Moreover, strategic investment emphasis moderates the strength of the effect of franchise ownership structure when firms franchise internationally. Overall, this research provides a novel empirical examination of franchising economics and has managerial implications for franchised channel structure.     

Strategic intent and performance: The role of resource allocation decisions

The notion that a firm's strategic intent can affect its performance through managerial actions has become prominent in the organization literature. In this research, we propose that strategic aggressive firms will foster decisions that favor holding low levels of slack and low levels of R&D investments, resulting in increased firm ROI, and that a firm's risk preference will moderate the indirect effect of strategic intent on performance. Findings from moderated mediation analyses on data from 130 firms in manufacturing industries support our hypotheses. Specifically, the indirect effect of a firm's strategic intent on a firm's performance is moderated by its risk aversion, such that when risk aversion is high, the indirect effect of strategic intent on performance through slack is strengthened. Similarly, the indirect effect of strategic intent on firm performance through R&D investments is strengthened, when risk aversion is high.     

Strategic Risk-Taking Propensity: The Role of Ethical Climate and Marketing Output Control

In the wake of the current financial crises triggered by risky mortgage-backed securities, the question of ethics and risk-taking is once again at the front and center for both practitioners and academics. Although risk-taking is considered an integral part of strategic decision-making, sometimes firms could be propelled to take risks driven by reasons other than calculated strategic choices. The authors argue that a firm’s risk-taking propensity is impacted by its ethical climate (egoistic or benevolent) and its emphasis on output control to manage its marketing function. The firm’s long-term orientation is argued to moderate the control–risk propensity relationship. The authors also extend research on risk and performance and argue that the association of risk-taking propensity and firm performance is contingent on the ownership (publicly traded versus privately held) structure of the firm. Based on survey data from a sample of manufacturing industries in the United States, the results show significant impact of ethical climate and marketing output control on a firm’s risk-taking propensity; also risk-taking propensity shows a stronger association with firm performance in privately held firms than in publicly traded firms.     

创新还是寻租？业绩期望落差对企业风险承担行为的影响

基于企业行为理论和参照点理论，探讨了业绩期望落差与企业创新性行为和寻租性行为之间的动态关系，并且考察了CEO权力和独立董事监督的调节作用。利用2013-2018年沪深A股制造业非国有上市公司的数据进行分析，结果发现：当期望参照点占主导地位时，随着业绩落差的增加，企业的长期风险承担意愿增强、短期风险承担意愿减弱，但当生存参照点起主导作用时，企业的长期风险承担意愿减弱，而短期风险承担意愿增强，因此业绩期望落差与创新性行为呈先增加后减少的倒U型关系，而与寻租性行为呈先减少后增加的U型关系。进一步研究发现，CEO权力弱化了业绩期望落差与寻租性行为的U型关系，独立董事监督强化了业绩期望落差与创新性行为的倒U型关系。研究深化了对业绩落差状态下企业风险承担行为的理解，丰富了企业行为理论的研究成果，对企业管理实践也有重要启示。     

Moderating Effects of Firm Age on the Relationship between Debt and Stock Returns

This article investigates the moderating effects of firm age on the relationship between debt and stock returns. The system generalized method of moment’s results indicate that firm age has a positive moderating effect on the relationship between book debt and stock returns. The results are robust, as firm age positively moderates the relationship between market debt and stock returns. Moreover, firm age has a direct positive effect on stock returns. Results suggest that as firms grow older, they use their experience to make effective capital structure decisions (i.e., optimal debt-equity mix) to maximize debt interest-tax-shield and increase shareholders’ returns.     

Are stocks dumped or neglected by analysts' inferior investments to covered stocks?

We compare the long-term stock price and operating performance of firms that are followed by analysts to those that are not over the period of 1994-2005. While analysts are skillful in identifying quality firms for coverage, the market is efficient in pricing both covered and neglected stocks such that risk-adjusted stock returns are compatible between the two groups. However, dumped stocks consistently outperform covered stocks with significant risk-adjusted returns across different market conditions and regulatory environments. Hence, investors might earn better returns by investing in dumped stocks, but the higher returns may represent compensation for greater search costs and information risk associated with investing in these stocks.     

CEO's Total Wealth Characteristics and Implications on Firm Risk

We study the connections between firm risk and the CEO's personal wealth characteristics, using a unique dataset on CEO wealth and its components. Consistent with decreasing absolute risk aversion, we find that wealthier CEOs are associated with higher risk firms. Riskier firms tend to have CEOs whose wealth is more independent of the firm. We also find that CEOs with high personal portfolio betas run firms with higher betas. CEO's tenure is negatively associated with firm risk measured either as beta, idiosynchratic risk, or volatility of accounting profitability. A possible interpretation is that risk‐averse managers are better able to imprint their risk preferences on the firm over time. Stronger corporate governance weakens the connection between CEO wealth characteristics and firm risk.     

Unveiling Contemporaneous Relations Between Jump Risk and Cross Section of Stock Returns

This study analyzes the impact of time varying jump risk on aggregate returns. We, in particular, examine the pricing of jump size and intensity components in the cross section of stock returns for four Asian markets. We use stochastic volatility model with jumps to estimate jump size and intensity. Fama–MacBeth regression results indicate that both jump size and intensity have statistically significant effect on expected returns. A one standard deviation increase in jump intensity beta lowers the expected annual returns by 1% for Japan, 2% for China, 5% for India, and 7% for South Korea. The results are consistent even after controlling for the Fama and French three factors, firm size, and liquidity proxies.     

Management commitment to innovation and esop stock concentration

The separation of ownership and control can lead to managerial entrenchment and a convergence of decision making and decision control. Decision-making refers to management's authority to make strategic and operating decisions while decision control refers to the ratification and monitoring of management decisions. Managers that possess decision control may behave in a risk-reducing manner relative to the behavior of owner managers because of management's desire to maximize job security Amihud and Lev 1981, McEachern 1975. For example, the managers of such firms may choose to diversify the firm into a wide variety of industries in an attempt to smooth revenues and earnings and avoid a series of peaks and valleys in the company's financial performance. These managers may believe that stable earnings will be viewed positively by shareholders and should help lessen the risk of stockholder action to replace upper-level management. Managers that possess both decision-making and decision-control capabilities may pursue a variety of risk-reducing strategies in addition to broad diversification.The existence of large outside investors has been shown to result in management becoming less risk-averse; management is more willing to adopt a wide range of strategies that present greater risk, but offer greater returns to shareholders. Hill and Snell (1988) found a significant, positive correlation between stock concentration and R&D intensity, indicating that large outside beneficial owners or dominant stockholders can influence management to pursue higher risk-higher return strategies. R&D intensity is used as a proxy for innovation and is generally operationalized as a firm's industry-adjusted R&D expenditures as a percentage of its sales. Findings of other studies also suggest that large investors are associated with decreased risk aversion by management. When controlling for the effects of time, previous R&D spending, liquidity, market share, diversification, market concentration, industry, and leverage, Hansen and Hill (1992) found a mild positive correlation between institutional stock concentration and R&D spending.This paper examines management's ability to utilize employee stock ownership plans (ESOPs) to facilitate managerial decision control or the capability to ratify and monitor decisions and subsequently adopt greater risk-reducing behavior. It is possible that management may adopt an ESOP to enhance entrenchment by placing a large block of the company's shares under the control of company managers and employees that are under the supervision of management. As a result, some ESOPs may not be effective alignment mechanisms since participants may find it difficult to organize a vote against management proposals or generate adequate enthusiasm and momentum to replace top-level managers. The paper anticipates that a positive relationship exists between the degree of ESOP stock concentration and the reduced risk-taking behavior of management. Specifically, the study argues that as ESOP stock concentration increases, management will likely behave in a risk-reducing manner and decrease its commitment to innovation, as measured by R&D intensity.Employee stock ownership plans (ESOPs) are qualified retirement plans under the Employee Retirement Income Security Act of 1974 (ERISA) and are treated similarly under the Act to other qualified pension plans with the exception of portfolio diversification. Employee stock ownership plans consist only of shares of the employer's stock and the performance of an ESOP-based retirement fund hinges with the market performance of that single stock. An agency theory framework would suggest that ESOPs that control large blocks of outstanding shares have an effect on management similar to that of other large investors and act to encourage management to craft and implement strategies that will yield superior financial and market performance. As ESOP stock concentration increases, agency theory proposes that ESOP participants would readily act to protect their interests and the interests of other shareholders. However, some previous research suggests that large ESOPs are not alignment mechanisms, but further entrench current management into their positions.Gordon and Pound (1990) found that management can use large ESOPs to increase effective insider ownership to protect against unwanted changes in corporate control. The authors suggested that ESOPs were less effective than other types of large investors at monitoring management decisions since ESOPs are unilaterally undertaken by management, ESOP shares are held only by incumbent managerial and non-managerial employees, and ESOP trustees are frequently appointed by management. The market has been shown to view an ESOP as a management entrenchment mechanism when the ESOP was adopted as a possible takeover defense Chang 1990, Dhillon and Ramirez 1994. The market reacts more favorably to an ESOP adoption when other large outside shareholders are present who have the capability to offset the influence of inefficient managers who might choose to use the ESOP to further entrench themselves into their positions (Park and Song 1995).The results of this study find that after the implementation of an ESOP, R&D intensity decreases as ESOP stock concentration increases. A significant negative relationship exists between ESOP stock concentration and change in industry-adjusted R&D intensity at the 0.05 level when controlling for firm size and change in profitability. The sample included firms where ESOP stock concentration represented as little as 3% of the employer's outstanding shares and as much as 67% of all outstanding employer stock. The sampled firms with the greatest ESOP stock concentration were associated with the greatest decreases in industry-adjusted R&D intensity after the implementation of the ESOP. The results suggest that management of high ESOP stock concentration firms became more risk-averse in regard to commitment to innovation after implementation of the ESOP.Agency theory adequately explains the effect of large outside stockholders on management's choice of strategy. Hill and Snell (1988) and Hansen and Hill (1992) have found that as stock concentration increases, incentive alignment becomes increasingly likely. The independent nature of large outside blockholders contributes to a separation of decision making from decision control, a reduction in agency costs, and a minimization of managerial risk-reducing behavior. As highly independent blockholder size decreases, decision making and decision control converge, and management entrenchment is more probable.Agency theory fails to adequately explain the effect of employee stock ownership on managerial risk-reducing behavior. Employee stock ownership does have the capability to align shareholder and employee interests under the proper conditions. However, ESOPs lack independence from managerial influence and are much less likely than outside institutional investors to monitor management decision-making and pressure management to adopt strategies that incorporate greater risk and an opportunity for greater returns. The study found that increased ESOP stock concentration was associated with greater managerial risk-reducing behavior. The results suggest that agency effects are more likely in firms with modest ESOP stock concentration since the ESOP does provide incentives for an alignment of interests, but does not provide management with a mechanism to block the actions of other large blockholders. ESOPs with higher levels of stock concentration are likely to facilitate management entrenchment by preventing some large percentage of shares from aligning with other large shareholders to challenge management decision-making. If other investors lack the capability to put full pressure on management, the monitoring and ratification of management decisions has been yielded to management. Therefore, a managerial entrenchment hypothesis is better suited than agency theory in explaining the effect of large ESOPs on management's risk-reducing behavior.     

When in peril, retrench: Testing the portfolio channel of contagion

The impact of past gains and losses on international investors' risk aversion is an important factor in the propagation of financial shocks across countries. We first present a stylized model illustrating how changes in investors' risk aversion affect portfolio decisions and stock prices. We then examine empirically the behavior of international mutual funds. When funds' returns are below average, they reduce their exposure to countries in which they were overweight and vice versa. An index of “financial interdependence” that reflects the extent to which countries share overexposed funds helps explain the pattern of stock market comovement across countries and the pattern of contagion during crises.     

Perceived Environmental Dynamism and Managerial Risk Aversion as Antecedents of Manufacturing Outsourcing: The Moderating Effects of Firm Maturity

This study investigates how perceived environmental dynamism and managerial risk aversion influence a firm's manufacturing outsourcing activities. Based on a survey of 86 small manufacturing firms, the study found that higher levels of perceived environmental dynamism and managerial risk aversion are associated with increased outsourcing activity. These relationships are moderated by firm maturity such that newer firms engage in more manufacturing outsourcing than their mature counterparts when the environment is perceived to be more dynamic. Mature firms were found to outsource more than newer firms when their top-management teams were relatively more risk averse.     

The relationship between online chatter and firm value

The visible trace of online communications has given rise to research on their effect on firm outcomes. The literature has established a link between online communication about a product and the product??s sales and price performance. On the assumption that financial markets understand this link, we conjecture financial markets consider the amount of online communication, or chatter, about a firm to be an indication of the firm??s performance in the marketplace. Our results confirm this conjecture. The relationship between stock returns and chatter are robust to alternative specifications of the model and to alternative measures of stock returns. We also investigate the issues of reverse causality and omitted variable bias driving a spurious relationship between stock returns and chatter. The data are not consistent with any of these alternative explanations for our results.     

Managerial power,perquisite consumption and the efficiency of property right system: Evidence from Chinese listed companies

This research uses data of Chinese listed companies during 2001–2004 to test the effects of managerial power on perquisite consumption and firm performance from the perspectives of CEO duality, ownership dispersion and long-term tenure of top executives. Results show that companies with higher managerial power tend to incur higher perquisite consumption, while their performance does not improve accordingly. Moreover, perquisite consumption fails to offer effective incentives to managers, and non-state-controlled listed companies have greater managerial power, higher perquisite consumption, and worse performance than that of their state-controlled peers. Results also show that managerial power is an important factor influencing compensation incentive.     

Shareholders versus stakeholders: corporate mission statements and investor returns

This paper seeks to discover whether companies that adopt a stakeholder approach, and thereby demonstrate a wider remit of corporate responsibility, provide inferior returns to those that embrace the shareholder value approach. To classify approaches, mission statements were analysed, the final sample comprising 32 shareholder oriented companies and 48 stakeholder oriented companies. To assess performance both accounting–based and market–based measures were used. A number of moderating variables were taken into account: systematic (beta) risk, gearing (long–term debt to total long–term finance), tax ratios, and firm size. ANOVA and Kruskall–Wallis tests revealed that mission orientation did not affect performance, whether in terms of stock returns or excess returns. Neither were accounting returns on equity different overall, although shareholder oriented companies experienced wider variations in this measure. A number of multiple regressions were also performed. However, the mission dummy was not found to be a significant variable.     

Pricing executive stock options with averaging features under the Heston–Nandi GARCH model

In this paper, we focus on the pricing issue of four types of executive stock options (ESOs) in the Heston–Nandi generalized autoregressive conditional heteroskedasticity option pricing model. Based on the derived benchmark strike prices in the proposed framework, we obtain the closed-form pricing formulae for four types of ESOs. In the numerical part, we investigate the sensitivity and cost efficiency of ESOs and suggest that systematic risk (stock β) and the fraction of wealth invested in restricted stock could impede the cost efficiency of ESOs.