Jean Canil

Executive Stock Options: Evidence that Premium and Discount Awards Do Matter

We document a structure of pre-effort conditions associated with ESOPs. Since we can observe shareholder returns at award we infer incentive effects in a setting where premium and discounted executive stock options are regularly awarded. Discounted (premium) awards are associated with the highest (lowest) exercise rates, implying a successful incentive (disincentive) effect. Exercise restrictions (comprising hurdles and vesting restrictions) necessarily lower exercise rates, but may be preferred in combination with a discounted or premium award. Typically, a discount choice is associated with hurdles but not vesting restrictions. Empirically, shareholders benefit most from regular awards which are discounted and do not have hurdle price restrictions. Shareholders also benefit from hurdle provisions in irregular awards which may expose shareholders to CEO opportunism.

CEO Pay Disparity: Efficient Contracting or CEO Entrenchment?

This paper investigates whether CEO pay disparity reflects efficient contracting or CEO entrenchment by exploiting an exogenous event which mandated option expensing, namely, the introduction of FAS 123R. Using a difference-in-difference approach, we find supportive evidence for the entrenchment hypothesis. Firms characterised by high pay disparity exhibit a significantly larger decline in options pre-versus post-FAS 123R than those characterised by low pay disparity. At the same time, firms with high pay disparity switch to salary more so than firms characterised by low pay disparity, consistent with entrenched CEOs preferring non-performance-based pay. Our findings suggest CEOs in high pay disparity firms exploited the free accounting cost advantage of options to inflate their pay rather than for their convexity property. These results are robust to alternative functional forms and measures of CEO pay disparity.

Are Employee Option Proceeds a Source of Finance for Investment

This paper investigates whether employee stock option proceeds, both executive and non-executive are employed by firms to finance investment by exploiting a quasi-natural experiment which mandated option expensing, SFAS 123R. We find that despite a fall in both executive and non-executive option grants and proceeds, investment has increased post-SFAS 123R. The investment’s sensitivity to option proceeds remains constant or even decreases for non-executive option proceeds post-SFAS 123R implying that option proceeds are not an integral source of finance. Our results are not driven by the recent financial crisis as well as the changes in corporate governance and financial constraints over the sample period.

A Test of the Incremental Power of CEO Productivity in Optimum Incentive Modelling

Employing a unique dataset with varying grant sizes and exercise prices, we test the competing optimal option incentive models of Hall and Murphy (2000, 2002) (HM) and Baker and Hall (2004) (BH) which differ with respect to the impact of CEO productivity on incentive determination and also the treatment of risk aversion and firm risk. Direct testing of the BH model proves more satisfactory than direct testing of the HM model, but given this outcome, it is surprising that the HM model explains a higher proportion of grant abnormal returns than does the BH model. We attribute this outcome to PPS and not the exercise price. Since exercise prices have been shown unrelated to agency problems, we conclude that caution needs to be exercised when prescribing exercise prices to create the optimal incentive, especially for highly risk-averse CEOs and those who are also poorly diversified.

Evidence that Executive Productivity Matters When Determining Optimal Incentive Levels

We document evidence that (absolute) grant size and exercise price choices in determining optimal pay-performance sensitivity are moderated by executive productivity. Specifically, we find that larger grants are associated with lower productivity, but we also find that in-the-money (ITM) grants are associated higher executive productivity. Given that large-firm CEOs in our Australian data set are less productive than small-firm CEOs in our sample, we show empirically that ITM grants rather than larger grants are preferred to incentivize less-productive CEOs.

DISCOUNT AND PREMIUM AWARDS IN THE CONTEXT OF PRE-EXISTING ESOP CONDITIONS

This study examines interactions between pre-award ESOP restrictive conditions and award discounts/premiums that characterized executive stock option awards in Australia from the mid1980s to 2000. Shareholder wealth effects at award suggest that (i) shareholders generally do not gain from offering discounts because associated value increments do not exceed the cost of the discount, (ii) premium awards coupled with exercise restrictions appear to be used to ameliorate the risk of CEO opportunism associated with irregular awards, and (iii) shareholders suffer a wealth decrement when premium awards are used to ameliorate the disinvestment incentive of inferior CEO dilution protection. The second of these findings implies risk of CEO opportunism. A major implication is that award discounts/premiums are used to modify the conditions of pre-existing ESOPs that presumably are dated and no longer optimal for addressing current incentive problems. Analyses of the optimality of award discounts/premiums should take this into account.