What drives the dating game of executive options exercise? Evidence from Taiwan

Examining Taiwanese firms from 2002 to 2008, this paper investigates the motivations behind backdating the exercising of executive stock options. The probability of suspect exercises (backdating) is positively related to the firm’s stock return, the value of the option, tax savings, institutional ownership and the extent of CEO equity ownership and negatively related to firm‐specific risk and the use of Big Four accounting firms. Tax incentives motivate executives to backdate the exercise date, implying that the greater the potential for larger tax savings, the greater the likelihood of backdating. Backdating usually occurs in firms that have heavy ownership by the CEO, have more claims to executive stock options and are not family‐run, confirming the presence of the agency cost problem.     

Stock price decreases prior to executive stock option grants

This study examines abnormal stock price changes prior to executive stock option grants. Executives have the incentive and opportunity to manage the timing of their communications of inside information to the market during the period just prior to the date of their stock-option grant so as to reduce the exercise price of their options. Executives benefit from temporary stock price decreases before the grant date and by stock price increases after the grant date. Executive stock option grants create a unique opportunity for insiders to profit by manipulating the timing of information flowing to the market without engaging in insider trading. Using data on 783 stock-option grants to chief executive officers, we find a statistically significant abnormal decrease in stock prices during the 10-day period immediately preceding the grant date.     

Optimal Incentive Contracts for Loss‐Averse Managers: Stock Options versus Restricted Stock Grants

This paper provides an explanation for the widespread use of stock option grants in executive compensation. It shows that the optimal incentive contract for loss‐averse managers must contain a substantial portion of stock options even when it should consist exclusively of stock grants for “classical” risk‐averse managers. The paper also provides an explanation for the drastic increase in the risk‐adjusted level of CEO compensations over the past two decades and argues that more option‐based compensation should be used in firms with higher cash flow volatility and in industries with a higher degree of heterogeneity among firms.     

Taxation and executive compensation: Evidence from stock options

Understanding the effects of taxes on executive compensation provides insight into the process determining this compensation and is a key input to top income tax rate policy. A 2010 tax reform in Canada, which greatly increased the effective tax rate on stock option compensation for a subset of firms, provides a natural experiment with which to address this issue. Difference-in-differences estimates suggest that this tax increase resulted in an immediate reduction in both stock option grants and the fraction of total compensation made up of stock options with limited, if any, substitution towards other components of compensation.     

Nonrecurring Accounting Transactions and Stock Option Grants

Abstract:  We examine the effect of nonrecurring accounting transactions on stock option grants for a sample of US companies. After controlling for both the economic and corporate governance-related determinants of option grants, we find that the aggregate value of stock option grants is more positively related to nonrecurring gains than to nonrecurring losses. We also examine whether the asymmetric treatment of nonrecurring gains and losses arises because (1) information contained in the nonrecurring transactions is related to firms' long-term prospects, (2) weak corporate governance fails to curb more favorable executive pay arrangements, (3) executives possess superior bargaining power in the labor marketplace, and (4) firms have significant growth opportunities. While we find no support for the first explanation and some support for the third, we find more consistent support for the growth explanation and two factors related to the corporate governance explanation: director-executive duality and the frequency of board meetings.     

Does backdating explain the stock price pattern around executive stock option grants?

Extant studies show that stock returns are abnormally negative before executive option grants and abnormally positive afterward. We find that this return pattern is much weaker since August 29, 2002, when the Securities and Exchange Commission requirement that option grants must be reported within two business days took effect. Furthermore, in those cases in which grants are reported within one day of the grant date, the pattern has completely vanished, but it continues to exist for grants reported with longer lags, and its magnitude tends to increase with the reporting delay. We interpret these findings as evidence that most of the abnormal return pattern around option grants is attributable to backdating of option grant dates.     

The Effect of CEO Option Compensation on the Capital Structure: A Natural Experiment

Firms simultaneously choose both their capital and their executive compensation structure. Using the Internal Revenue Code 162(m) tax law as an exogenous shock to compensation structure in a natural experiment setting, I identify firm leverage changes as a result of chief executive officer (CEO) option compensation changes. The evidence provides strong support for debt agency theory. Firms appear to decrease leverage when CEOs are paid with more options and when CEO options become a higher percentage of future cash flows. The findings are robust to controlling for corporate governance and convertible debt.     

Stock repurchases: How firms choose between a self tender offer and an open-market program

In practice, open-market stock repurchase programs outnumber self tender offers by approximately 10–1. This evidence is puzzling given that tender offers are more efficient in disbursing free cash and in signaling undervaluation – the two main motivations suggested in the literature for repurchasing shares. We provide a theoretical model to explore this puzzle. In the model, tender offers disburse free cash quickly but induce information asymmetry and hence require a price premium. Open-market programs disburse free cash slowly, and hence do not require a price premium, but because they are slow, result in partial free cash waste. The model predicts that the likelihood that a tender offer will be chosen over an open-market program increases with the agency costs of free cash and decreases with uncertainty (risk), information asymmetry, ownership concentration, and liquidity. These predictions are generally consistent with the empirical evidence.     

Executive Financial Incentives and Payout Policy: Firm Responses to the 2003 Dividend Tax Cut

We test whether executive stock ownership affects firm payouts using the 2003 dividend tax cut to identify an exogenous change in the after‐tax value of dividends. We find that executives with higher ownership were more likely to increase dividends after the tax cut in 2003, whereas no relation is found in periods when the dividend tax rate was higher. Relative to previous years, firms that initiated dividends in 2003 were more likely to reduce repurchases. The stock price reaction to the tax cut suggests that the substitution of dividends for repurchases may have been anticipated, consistent with agency conflicts.     

Compensation committee governance quality,chief executive officer stock option grants,and future firm performance

This paper examines whether the relationship between future firm performance and chief executive officer (CEO) stock option grants is affected by the quality of the compensation committee. Compensation committee quality is measured using six committee characteristics – the proportion of directors appointed during the tenure of the incumbent CEO, the proportion of directors with at least ten years’ board service, the proportion of directors who are CEOs at other companies, the aggregate shareholding of directors on the compensation committee, the proportion of directors with three or more additional board seats, and compensation committee size. We find that future firm performance is more positively associated with stock option grants as compensation committee quality increases.