Menachem Abudy

How Much Can Illiquidity Affect Corporate Debt Yield Spread

We present a structural method for measuring the upper bound for the illiquidity risk of liabilities issued by a levered firm. The method calculates the upper bound of illiquidity spread of a corporate bond given its duration and the issuing firm’s asset risk and leverage ratio. Consistent with the empirical literature the illiquidity spread is positively related to the issuing firm’s asset risk and leverage ratio and the illiquidity component increases with a bond’s credit quality. The term structure of illiquidity spread has a humped shape, where its maximum level depends on the firm’s leverage ratio. Finally, we demonstrate how the method’s implied restricted trading period can be used as a measure for illiquidity in the bonds’ market.

Do Executive Compensation Contracts Maximize Firm Value? Evidence from a Quasi-Natural Experiment

We find significant positive abnormal returns surrounding a surprising and quick enactment of a law that restricts executive pay to a binding upper limit in a few industries. We find that the effect is concentrated only for firms in which the restriction is binding. We also find that the increase in value is greater for firms with weaker corporate governance and smaller for firms that grant a greater portion of equity-based compensation to their executives. These results provide indications that, on average, compensation contracts can be set in a way that does not maximize firm value.

The Cost of Equity for Private Firms

The paper presents a method for calculating the cost of equity capital for the non-marketable securities of private firms and its difference from the cost of equity capital of an all else equal public firm (the private firm premium). The method is based on a theoretical framework that assumes the investor is undiversified due to her holdings in non-marketable securities. We implement the method for both unlevered and levered firms, and also consider the effect of taxes. The findings indicate that the private firm premium increases with the firms asset risk, its leverage ratio, and the non-diversification of the private firms owner, while taxes are negatively related to the private firm premium.

Employees’ Attitudes Toward Equity-Based Compensation

This article presents a field study that examines the subjective value of equity-based compensation and investigates the relationship between attitude toward risk and compensation preferences. The participants in the field survey received equity-based compensation in the past but lack financial education background. We find that the respondents exhibit difficulty in estimating the value of employee stock options, which usually results in a subjective value that is lower than the objective value (calculated using the Black–Scholes model). Additional findings demonstrate the presence of behavioral biases such as priming and mental anchoring. Finally, we document an absence of transitivity in the preferences of 10% of the respondents.

Valuing Restricted Stock Grants to Non-Executive Employees

We estimate the value of restricted stock (RS) grants to non-executive employees using a unique proprietary database by calibrating theoretical models that account for the non-marketability of securities and the potential effects of the employees non-diversification. The calibration results predict an average discount of 30.3% on the RS grant. This discount depends on firm and industry characteristics, is significantly higher during the financial crisis and robust across time and across industries. The discount increases when the employee is undiversified because of the granted stocks. The findings contribute to the discussion on the efficiency of RS grants to non-executive employees, which became a dominant form of equity-based compensation.

Taxation and the value of employee stock options

Purpose - This paper aims to derive firm value implications for various kinds of employee stock options (ESOs) in a framework that considers uncertainty, non-diversification and the US statutory tax treatment. Design/methodology/approach - The authors extend the analysis of ESOs from the case of perfect capital markets to two cases of imperfect capital markets using the Benninga-Helmantel-Sarig framework. Findings - It is found that ESOs are inferior to cash compensation and that the degree of option inferiority depends on employee diversification. In addition, incentive stock options (ISOs) are generally inferior to non-qualified stock options (NSOs). This relative profitability of the NSO versus ISO increases as market imperfections are added. The authors also find that in general firm hedging of ESOs is suboptimal. Originality/value - The paper highlights the firm value of employee stock options.