John M. Bizjak

An Empirical Examination of the Role of the CEO and the Compensation Committee in Structuring Executive Pay

Motivated by the potential for opportunistic behavior in pay decisions, recent SEC and IRS regulations essentially preclude inside directors from serving on a firms compensation committee. In this paper, we examine whether greater compensation committee independence promotes shareholder interests and, in particular, whether the CEOs presence on the compensation committee leads to opportunistic pay structure. We find some evidence that the greater outsider representation on the committee the higher levels of pay and the greater the sensitivity of pay to performance. Any differences we find in committee structure and committee controlled pay, however, are offset by differences in ownership. When considering both pay and ownership, we find no relationship between committee structure and total incentives. Interestingly, for CEOs who are members of the compensation committee, we find that they are modestly paid (in terms of salary and option pay) and own a lot of equity. When considering both incentive pay and ownership, the sensitivity of total wealth to firm performance is greater for CEOs who sit on the compensation committee. Finally, we do not find any evidence that CEO pay decreases or that total incentives increase when CEOs come off the compensation committee. Our results suggest that regulations governing committee structure may not reduce levels of pay or achieve efficiencies in incentive contracts.

The Shareholder Wealth Implications of Corporate Lawsuits

Large revisions in dividends are accompanied by stock price reactions for industry rivals of the announcing firm. Though these effects are near-zero on average, their magnitude differs systematically across the firms in the industry. Rivals that are unlikely to be affected by competitive realignments within the industry tend to experience stock price effects like those of the announcing firm. Those that are likely to be affected tend to experience statistically insignificant reactions of the opposite sign. Thus, for some rivals, competitive effects apparently offset contagion effects. We find supporting results for changes in rivals dividends over a longer period. We examine the intra-industry information effects of announcements of dividend initiations. Our results indicate that the stock prices of industry competitors do not react to dividend initiations. Further, analysts do not revise their earnings forecasts for nonannouncing, rival firms. These findings are not sensitive to the manner in which we estimate abnormal returns or calculate forecast revisions. Thus, the information conveyed to the market by the decision to initiate dividends contains no industry-wide component. Dividend initiation appears to be a firm-specific event.

Managerial Ownership, Incentive Contracting, and the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders

Zero-cost collars and equity swaps provide insiders with the opportunity to hedge the risk associated with their personal holdings in the companys equity. Consequently, their use has important implications for incentive-based contracting and for understanding insider trading behavior. Our analysis indicates that these transactions generally involve high-ranking insiders and effectively reduce their ownership by about 25%, on average. Given the potential of these financial instruments to substantially alter the incentive alignment between managers and shareholders, we suggest that increasing the transparency of these transactions may provide valuable information to investors.

Are All CEOs above Average? An Empirical Analysis of Compensation Peer Groups and Pay Design

Companies can potentially use compensation peer groups to inflate pay by choosing peers that are larger, choosing a high target pay percentile, or choosing peer firms with high pay. Although peers are largely selected based on characteristics that reflect the labor market for managerial talent, we find that peer groups are constructed in a manner that biases compensation upward, particularly in firms outside the Standard & Poors (S&P) 500. Pay increases close only about one-third of the gap between the pay of the Chief Executive Officer (CEO) and the peer group, however, suggesting that boards exercise discretion in adjusting compensation. Preliminary evidence suggests that increased disclosure has reduced the biases in peer group choice.

Are Shareholder Proposals All Bark and No Bite? Evidence from Shareholder Resolutions to Rescind Poison Pills

We provide a comprehensive examination of shareholder resolutions to rescind poison pills. We find that pill rescission proposals are more frequent the more negative the market reaction to the initial pill adoption and the lower the insider and unaffiliated block ownership. Votes for such a proposal increase when performance is poor and for more onerous poison pills. While we document a stock price decline associated with the proposal announcements, we find poison pills are more likely to be restructured or rescinded when there is a shareholder resolution. Moreover, pill revisions are associated with stockholder wealth increases. Collectively, our results suggest that pill rescission proposals are more frequent when the pill is more likely to harm shareholders and that managers respond to shareholder proposals.

Stock and Option Grants with Performance-Based Vesting Provisions

We assemble a sample of 983 equity-based awards that include either an accelerated- or a contingent-vesting provision tied to firm performance and explore the frequency, contractual nature, usage, and implications of such awards. We find that performance-vesting (p-v) provisions specify meaningful performance hurdles and provide significant incentives for executives. The propensity to use p-v provisions is positively related to the arrival of a new CEO and the proportion of outsiders on the board of directors and negatively related to prior stock performance. Performance-vesting firms have significantly better subsequent operating performance than control firms. Abnormal accounting performance does not arise from earnings management or discernible differences in financial or investment policy. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Insider Trading in Derivative Securities: An Empirical Examination of the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders

We provide an examination of the use of zero-cost collars and equity swaps by corporate insiders to hedge the risk associated with their personal holdings in the companys equity. These financial instruments have important implications for insider trading and incentive-based contracts. Our analysis indicates that these transactions generally involve high ranking insiders (CEOs, board members and senior executives) and cover over a third of their equity holdings. We also find that insiders appear to initiate hedging transactions immediately following large price runups, prior to increases in stock price volatility, and prior to poor earnings announcements. In addition, abnormal returns following insider hedging activities are more negative than those associated with ordinary insider sales. Overall, the evidence indicates that executives can use these hedging instruments to significantly alter their effective ownership positions in the firm.

Performance-Vesting Provisions in Executive Compensation

The usage of performance-vesting (p-v) equity awards to top executives in large U.S. companies has grown from 20 to 70 percent from 1998 to 2012. We measure the effects of p-v provisions on value, delta, and vega of equity-based compensation. We find large differences in the value of p-v awards reported in company disclosures versus economic value. We also find that equity-based grants continue to convey significant compensation convexity (vega) after ASC 718 (2005) and that, counter to recent claims in the literature, our analysis empirically reaffirms the presence of a causal relation between compensation convexity (vega) and firm risk.

Performance-Contingent Executive Compensation and Managerial Behavior

Recent regulation and legislation, along with the growing influence of compensation consultants and proxy advisors, have led to an increase in performance-contingent awards. A majority of these awards contain performance conditions tied explicitly to accounting measures. Both the structure of the awards and the opaqueness of award disclosures can provide incentives for earnings management. Our examination reveals no evidence of earnings management through discretionary accruals. In contrast, we find evidence of real activities management. Earnings management varies with accounting metric type, award disclosure opaqueness, and proximity of earnings to performance thresholds. Results are robust to accounting for endogeneity in performance-contingent awards. Our evidence suggests that recent trends in the structure and transparency of pay affect both the incentives for managing earnings and the form of earnings management.

Modeling Equity Compensation with Accounting Contingencies

Of late, both U.S. and International firms have increased the granting of performance-contingent equity awards to their executive officers. Beyond simple stock options, these awards frequently include accounting-based performance targets. Failure to meet or exceed these targets causes award forfeiture. While now a common component in executive pay, little is known about how to value these instruments. In this paper, we model the expected payoff from an equity award with accounting-based payout conditions. The model incorporates numerous characteristics of awards seen in practice, including the coupling of stock price and accounting targets, multiple accounting targets, sliding payout schedules, and the adoption of both “and” and “or” conditions that trigger payout. We also translate the expected payoff into an approximate present value. Given the growing prevalence of performance-contingent features in executive pay, this exercise is important to academics, board members and shareholders, along with other market participants and regulators.