Rev Manag Sci DOI 10.1007/s11846-015-0174-8 ORIGINAL PAPER
Countermove: how CEOs respond to post-acquisition compensation adjustments John S. Marsh1 • William J. Wales2 • Fariss-Terry Mousa3 • Rachel Graefe-Anderson4
Received: 7 August 2014 / Accepted: 27 May 2015 Springer-Verlag Berlin Heidelberg 2015
Abstract Following poorly performing acquisitions, the board of directors often redesigns the CEO’s annual compensation package to include less risk-encouraging stock options and more risk-discouraging restricted stock. This study explores the emerging area of post-acquisition compensation management and proposes that CEOs can indirectly, but effectively, defend against compensation rebalancing. Specifically, we find that CEOs may counteract the effects of compensation rebalancing by delaying the exercise of existing stock option holdings. Fortunately, this insight also offers valuable implications including the ability of the board to limit the CEO’s defense by adjusting stock option exercise windows. Keywords Acquisitions CEO compensation Stock options Corporate governance & John S. Marsh
[email protected] William J. Wales
[email protected] Fariss-Terry Mousa
[email protected] Rachel Graefe-Anderson
[email protected] 1
College of Business, University of Mary Washington, 1301 College Avenue, Fredericksburg, VA 22401, USA
2
School of Business, University at Albany, SUNY, 1400 Washington Avenue, Albany, NY 12222, USA
3
Department of Management, James Madison University, 800 S. Main Street, Harrisonburg, VA 22801, USA
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Smeal College of Business, The Pennsylvania State University, 210 Business Building, University Park, PA 16802, USA
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JEL Classification
G34 J33 M12
1 Introduction In late 2014, shareholders of Coca-Cola started to call for limits to the compensation of its CEO. They cited major recent, and expensive, acquisitions including $4.1 billion for VitaminWater’s Galceau in 2007 and in 2014 $3.6 billion for a 16 % minority stake in Keurig Green Mountain and $2.15 billion for a 17 % minority stake in Monster energy drinks. After several quarters of flat growth, Coca-Cola’s shareholders became restless with the expensive acquisition spending. Suggestions that Coca-Cola might divest its low-margin bottling operations, after spending over $15 billion to acquire it in only 2010, caused shareholders to question whether the acquisitions were actually in the long-term best interest of the company. Shareholders called for limits on pay, or even the dismissal, of CEO Muhtar Kent. Yet, directors assured investors that there was no reason for concern They had already taken action by adjusting Mr. Kent’s compensation package to be weighted more heavily in shares of restricted stock and less in stock options to better align incentives with shareholders. Still, some shareholders were not satisfied. This paper tries to explain why (Chakrabarty and Sharma 2014). Mergers and acquisitions (M&A’s) present CEOs with a significant means for improving their own compensation (Kroll et al. 1990). Boards typically reward CEOs with large cash bonuses for completing an acquisition, on average between $500,000 (Harford and Li 2007) and $1.1 million (Grinstein and Hribar 2004) as well as additional stock and stock options that estimates have valued at around $500,000 (Harford and Li 2007). Further compensation in itself is not a problem. However, these bonuses do not appear to depend upon the performance of the acquisition (Bliss and Rosen 2001; Dorata and Petra 2008; Girma et al. 2006; Guest 2009). This is even more surprising given that the majority of M&A’s ultimately fail to achieve their intended returns (Agrawal et al. 1992; Ferreira et al. 2014; Homberg et al. 2009; Porter 1987). As a result, this additional compensation offers managers an incentive to pursue acquisitions independent of the best interests of the firm (Jensen and Murphy 1990; Morck et al. 1988, 1990; Ravenscraft and Scherer 1987; Trautwein 1990). In response to this problem, the acquisition literature has focused considerably upon the question of how firms can best structure their compensation and governance practices to improve acquisition performance. Research has indicated that stock ownership by the CEO and directors, as well as the presence of external directors, large independent shareholders, and more scrutiny by financial analysts, have all been linked to fewer and better performing acquisitions (Agrawal and Mandelker 1987; Amihud and Lev 1981, 1999; Bethel and Liebeskind 1993; Datta et al. 2001; Deutsch et al. 2007, 2010; Johnson et al. 1993; Kroll et al. 1997; Lewellen et al. 1985; Walters et al. 2007; Wright et al. 2002). Stock options, on the other hand, have been linked to more frequent and often lower performing acquisitions because they offer CEOs a financial incentive to take risks (Fogarty et al. 2009; Sanders 2001; Sanders and Hambrick 2007).
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Recently, Spraggon and Bodolica (2011) observed that boards react to poor acquisitions by renegotiating CEO compensation packages to include more restricted stock and fewer stock option grants. This shift in compensation from stock options to restricted stock (referred to as ‘‘compensation rebalancing’’) is intended to reduce the risk-seeking stock option incentive for CEOs to pursue risky acquisitions for personal gain.1 Although this restructuring of future compensation packages serves to ‘penalize’ CEOs for undertaking a poorly performing acquisition, opportunities for personal gain from engaging in acquisitions still remain. Even if boards greatly reduce acquisition-related bonuses, acquisitions commonly allow CEOs to unrestrict formerly restricted stock option holdings, an act that has been estimated to be roughly equivalent to an additional $6 million in compensation on average (Cai and Vijh 2007; Guest 2009). Furthermore, CEOs can still enjoy the power, prestige, and excitement that stems from managing a larger and more diverse company (Amihud and Lev 1981; Baumol 1967; Schoar 2002; Williamson 1963). Alternately, CEOs may wish to pursue additional acquisitions out of hubris or overconfidence concerning the potential performance of these acquisitions (Roll 1986). Regardless of the source, CEOs have incentives to find a way to reduce or counter-balance the disincentives from additional restricted stock and again enjoy the immense personal upside associated with steering their firms toward the undertaking of subsequent acquisitions. This paper proposes a mechanism in which CEOs can undermine board’s efforts to rebalance compensation packages. In particular, we argue that by refraining from exercising already held stock options, CEOs can increase their overall option holdings despite the reduction in the number of options granted each year. Thus, by exercising fewer options the CEO can accumulate more risk-encouraging stock options despite the board’s efforts to reduce such stock option awards and increase risk-discouraging restricted stock awards. Using data on acquisitions completed by publicly traded corporations, we explore this behavior. In doing so, this paper responds to the growing call for theoretical insights which advance the understanding of complex behavioral phenomena such as CEO compensation management (Bodolica and Spraggon 2009; Magnan et al. 1998; St-Onge et al. 2001). This paper seeks to contribute to the literature on post-acquisition compensation management, an understudied area with substantial implications for long-term acquisition success, by illustrating how CEOs can respond to the rebalancing of their annual compensation packages. The contribution offered herein is significant for a number of reasons. First, recent work has discovered that boards rebalance compensation to replace risk-encouraging stock options with risk-discouraging restricted stock. However, the CEOs’ reactions to this rebalancing is not yet explored. This paper introduces a novel model that describes how CEOs can self-manage their compensation to preserve or create incentives to pursue additional acquisitions after experiencing compensation rebalancing. 1
It is worth noting that boards replace stock options with restricted stock in annual compensation grants, yet the risk effects of stock and stock options are based on overall holdings. Spraggon and Bodolica (2011) argue that the shift in annual compensation ultimately influences overall stock and option holdings, thereby contributing to the behavioral incentive and disincentive effects concerning future acquisitions.
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Second, this contribution is particularly notable because extensive prior work has established that stock options offer CEOs strong incentives to pursue acquisitions and CEOs are speculated to actively manage their compensation portfolios to engineer those incentives. However, this study discovers that CEOs actually take steps to preserve those incentives—even when the organization’s board of directors tries to remove them. Third, this discovery has strong implications for research on serial acquisition patterns. Studies of frequent acquirers have commonly examined the effects of compensation structure on patterns of acquisition behavior; however these models have generally used compensation structure as an exogenous input variable or as an ex post result. Our model is unique in that it offers evidence that the CEO has a strong role in endogenously managing compensation structure in a way which preserves incentives for future acquisitions. Fourth, although studies on CEO hubris predict that overconfident CEOs will also refrain from exercising stock and stock options, our study introduces a novel incentive-based model which is highly generalizable and does not require CEO overconfidence or other irrationality. Fifth, unlike prior work on compensation rebalancing, this paper does not find evidence of a link between compensation rebalancing and acquisition performance. Our results suggest that compensation rebalancing occurs subsequent to poorly performing acquisitions, but also occurs subsequent to successful acquisitions. In noting this inconsistency and the differences in the methodology used here and in prior work, this evidence suggests the possibility of moderators which may influence the adoption of compensation rebalancing by the board of directors. As such, important directions for future research are offered. Sixth, in exploring CEOs’ responses to compensation rebalancing, this paper introduces novel implications for managers. Specifically, calls by earlier researchers for increased stock-based compensation may be less effective than hoped. CEOs may have a salient defense against compensation rebalancing. However we also propose a solution: directors should be able to achieve the desired rebalancing through the management of option exercise windows. The rest of the paper is arranged as follows. Section 2 reviews the literature on acquisitions and CEO compensation, develops our multi-perspective argument regarding how CEOs will respond to compensation adjustments, and presents our hypotheses. Section 3 describes our data sources, sample, variables and controls. Section 4 empirically tests our hypotheses. Section 5 summarizes our results and discusses several theoretical and managerial implications and limitations of our study. Section 6 concludes.
2 Development of hypotheses The hypotheses are developed in three stages. First, the relevant literature regarding the risk incentives that restricted stock and stock options have on M&As is reviewed. Second, a three-perspective framework is used to develop an explanation for how CEOs will respond to attempts by the board of directors to readjust
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compensation packages. Third, this section concludes with the development of testable hypotheses that provide evidence of this behavior. 2.1 Stock, stock options, and acquisitions Acquisitions represent an inherently risky strategic decision for a company. Absent any incentives, a typical CEO will wish to avoid that risk. From an agency perspective, the firm uses incentive-based compensation, such as stock and stock options, to encourage CEOs to pursue acquisitions that may create value for the firm (Jensen and Meckling 1976). Incentive-based compensation is designed to reward the CEO if the acquisition succeeds in creating value for the firm (Bliss and Rosen 2001; Datta et al. 2001; Jensen and Murphy 1990; Ofek and Yermack 2000; Shleifer and Vishny 1997; Yermack 1995). However, from a behavioral perspective, incentive-based compensation, such as stock and stock options, will instead discourage CEOs from making risky decisions by placing more wealth at risk (Tortella et al. 2005; Wiseman and Gomez-Mejia 1998). Unexercised stock and stock options are seen as ‘‘wealth at-risk’’ whose value could change with the performance of the firm and, as risk-averse agents, CEOs will seek to make decisions that will preserve the value of their wealth (Kahneman and Tversky 1979; Tortella et al. 2005; Tversky and Kahneman 1991). In sum, agency scholars view the potential for gain from stock and stock options as risk-encouraging while behavioral scholars view the potential for loss from stock and stock options as riskdiscouraging (Martin et al. 2013). In parallel with these theoretical arguments, a growing body of evidence suggests that stock and stock options have quite different implications as incentive mechanisms. This is due to key differences in the way in which stock and stock options operate. While stock and stock options both increase in value in tandem with the firm’s stock price, stock options have a limit on how much they can fall in tandem with the firm’s stock price. Stock options are generally issued ‘‘at the money’’ with zero value and with the ability to rise from there; but without the ability to fall to a point of being worth less than zero (Chen and Pelger 2013; Kanniainen 2010; Miller and Leiblein 1996). Existing option holdings that have already risen in value can fall, but can only fall as far as their original exercise price. Because the value of stock options starts at zero, it can only increase. On the other hand, stock already has a value that can decline. Consequently, recent studies have found that restricted stock with greater downside risk is associated with fewer and better performing acquisitions (Datta et al. 2001; Kroll et al. 1997). But stock options with limited downside risk are associated with more frequent and riskier acquisitions (Sanders 2001; Sanders and Hambrick 2007; Wright et al. 2002). In-depth case studies have found strong evidence of this behavior. Fogarty et al. (2009) noted that in the 1990s, Nortel Networks enjoyed explosive growth in the telecommunications industry, largely through an aggressive acquisition strategy. While this growth often resulted in significant short-term gains to transient stockholders, it also led to substantial long-term value destruction and the eventual demise of the company. The focus on short-term gains, through acquisitions, has been attributed to the near record-setting stock option compensation of its chief
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executive. Examination of these stock options revealed huge financial incentives for the executives to grow the company and please short-term investors, by any means necessary (Fogarty et al. 2009). Similar analysis by Andre et al. (2008) of the merger between AbitibiConsolidated Inc. and Donohue Inc., which created the largest newsprint producer in the world at the time, found similar incentives. Both the acquiring and target CEOs’ compensation packages heavily favored stock options, and both enjoyed tremendous personal financial gains. The outgoing CEO received considerations with an estimated value greater than $20 million (with the majority of that value coming from early exercise of stock options) and the acquiring CEO enjoyed a 62 % increase in annual salary, greater than 100 % increase in annual stock option grants and pension benefits, and nearly six-fold increase in annual cash bonuses. This occurred despite an 18–26 % decline in stock value for the acquiring Abitibi shareholders after the merger announcement (Andre et al. 2008). In these cases, stock options have been attributed to patterns of agent-driven acquisitions that financially reward the CEO at the cost of shareholders. Yet, restricted stock appears to instead induce more risk-avoiding behavior. Because of these asymmetrical incentives, scholars are increasingly arguing that the riskseeking agency perspective better describes the effect stock options have on decision making while the risk-averse behavioral perspective better describes the effect shares of restricted stock have on decision making. Practically, boards seem to be aware of this duality. Following acquisitions with high acquisition premiums and low post-acquisition stock returns, boards have been observed to rebalance CEO annual compensation packages to include more restricted stock and fewer stock options (Spraggon and Bodolica 2011) and remove compensation protection plans (Bodolica and Spraggon 2009). In effect, boards ‘punish’ managers who engage in poorly performing acquisitions by replacing riskencouraging option-based compensation with risk-discouraging stock-based compensation. However, as mentioned in the introduction, CEOs still have strong incentives to pursue acquisitions. Even if they find their compensation package restructured, acquisitions still commonly result in significant bonuses and unrestriction of existing stock and option holdings. Nonfinancially, acquisitions offer additional power, prestige, and excitement from managing a larger and more diverse company (Amihud and Lev 1981; Baumol 1967; Schoar 2002; Williamson 1963). Furthermore, overconfident CEOs driven by hubris, or their own over-estimation of their ability to create value from acquisitions, have strong incentives to pursue subsequent acquisitions (Roll 1986). Regardless of the source of the incentives, CEOs have strong personal incentives to structure their pay packages to encourage further acquisitions. Consequently, there exists a strong possibility that CEOs whose pay has been rebalanced would wish to return their pay packages to their pre-adjustment state to maintain their risk incentives to engage in future acquisitions. Although an economic perspective suggests that a CEO could offset post-adjustment increases in restricted stock grants by selling existing unrestricted stock holdings, a symbolic management perspective might suggest that the CEO would also value avoiding
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actions which might send a signal that they are not fully invested in the success of their company, particularly following a questionable acquisition (Zajac and Westphal 1997). Given these different viewpoints, this paper builds upon the notion that developing a more complete picture of CEO compensation management behavior requires consideration of multiple perspectives (Magnan et al. 1998; Martin et al. 2013; St-Onge et al. 2001; Westphal and Zajac 1994) and that no theory alone can fully represent all the complexities related to executive compensation (Bodolica and Spraggon 2009). Thus, this manuscript builds on the work of Bodolica and Spraggon (2009) and uses Zajac and Westphal’s (1997) three organizational decision-making perspectives—economic, political, and symbolic—to develop an explanation for how CEOs will respond to compensation rebalancing. To briefly summarize the core arguments of these three perspectives, the economic perspective describes the potential wealth gains from incentive-based pay and the risk-asymmetry between stock and stock options. According to this perspective, the CEO will wish to take actions that increase his or her potential for wealth or reduce his or her compensation risk. The political perspective describes the ability of the CEO to influence the board of directors and strategic decision making. From this perspective the CEO will wish to take actions that increase his or her influence in managerial decisions. The symbolic perspective asserts that the actions the CEO takes send symbolic messages to directors and shareholders. According to this perspective the CEO will prefer to send messages that are received favorably by the directors and shareholders. As we argue in the following section, CEOs possess a means to undermine the intended incentive effects of compensation rebalancing that will still be viewed favorably from all three of these perspectives. 2.2 The economic perspective From an economic perspective, CEOs desire the personal gains that may result from undertaking additional acquisitions including cash and option bonuses (Grinstein and Hribar 2004; Harford and Li 2007), additional annual compensation for managing a larger company (Bliss and Rosen 2001), and the power, prestige, and excitement of managing a larger company (Amihud and Lev 1981; Schoar 2002). Absent risk effects, CEOs have substantial personal incentives for pursuing acquisitions. However, as discussed earlier, following a poorly performing acquisition, the board of directors often rebalances the CEO’s compensation package to contain fewer stock options and more restricted stock. The shift from stock options to restricted stock changes the risk effects of the incentive-based compensation away from the risk-encouraging agency viewpoint and towards the risk-discouraging behavioral viewpoint. Ostensibly, this shift is intended to encourage the CEO to focus on only firm-enhancing acquisitions and discourage additional self-rewarding acquisitions by more strongly linking the CEO’s compensation to the performance of both well and poorly performing acquisitions (Sanders 2001; Sanders and Hambrick 2007).
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However, if CEOs could find a way to return their compensation packages to their original balance, it would remove the disincentives introduced by compensation rebalancing. Three basic mechanisms exist for achieving this goal2: renegotiation with the board of directors to return the CEO’s compensation package to its original form, selling shares of stock, and/or delaying exercising existing holdings of stock options. From an economic perspective, renegotiation with the board provides a direct remediation that returns the CEO’s compensation package to its original state. However, a CEO is unlikely to possess the political power to restore his or her compensation package immediately following board intervention, particularly after a poorly performing acquisition. Selling shares of stock also provides a direct solution to the increase in shares of restricted stock granted. Although new shares are typically restricted and unable to be sold, CEOs generally have numerous existing holdings of unrestricted stock in their own company (Cai and Vijh 2007). Some of these unrestricted shares could be sold to offset the increase in restricted shares granted, thus effectively nullifying the newly granted shares (Jin and Kothari 2008; Ofek and Yermack 2000). From a behavioral point of view, this option would allow the CEO to reduce their wealth at risk (Wiseman and Gomez-Mejia 1998). Yet, as argued in the following sections a CEO who is reducing investment in his or her own company may be sending a powerful signal that the CEO is not confident of the company’s future success. It is worth noting that it is possible for a CEO to be overly invested in the firm. Agency theory has long discussed the problems of excessive risk-aversion from non-diversified CEO-owners (Jensen and Murphy 1990). Overconfident CEOs are also likely to over-invest in their firm in expectation of future gains (Brown and Sarma 2007; Malmendier and Tate 2005, 2008). However, as discussed later, it remains that a CEO that reduces ownership in the firm, particularly after the directors took steps to increase ownership, will be sending a negative signal. Delaying the exercise of existing stock options presents a less-direct, but potentially effective solution. Although chief executives may be unable to independently increase the number of stock options granted as part of their annual compensation, they can adjust how they manage the stock options that they already have.3 If a CEO reduces or postpones exercising existing stock option holdings, stock option holdings can accumulate, increasing the overall number of stock options held. According to the agency perspective, these additional option holdings increase the risk-seeking incentives of a CEO’s compensation system (Jensen and Murphy 1990). If enough options are accumulated, these holdings can outweigh the disincentives that come from additional restricted stock grants and restore the CEO’s ability to pursue additional acquisitions. 2
A fourth approach to dealing with rebalanced compensation is for the CEO to leave the firm for another firm and renegotiate with a new board of directors. While an interesting avenue for additional research, this study limits itself to exploring how the CEO can respond to his or her existing board of directors to undermine the board’s efforts to rebalance CEO compensation.
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There may also be salient political and symbolic implications for refraining from exercising stock options. These considerations are discussed in the following sections.
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It is worth noting that from the behavioral perspective, accumulating options is a second-best solution for a CEO. Accumulating stock options can be undesirable because it can place additional wealth at risk, but CEOs would rather accumulate options than restricted stock. Options represent lower downside risk and therefore less wealth at risk than accumulated restricted stock would. However, in this situation there are two mitigating factors. First, compensation rebalancing typically occurs in response to poorly performing acquisitions. Following poor stock market performance, the value of stock options is likely to have fallen significantly and therefore represent much less wealth at risk as compared to CEOs whose acquisitions performed well and compensation was not rebalanced. Second, the personal gains from pursuing acquisitions are relatively certain and normally riskaverse agents have been found to take limited risks in pursuit of likely gains (Chatterjee et al. 1999; Sitkin and Weingart 1995). Therefore, we argue the following: the first-best behavioral solution of selling restricted stock is undesirable from the symbolic and political decision-making perspectives, the wealth risk associated with holding options following rebalancing is lower due to fewer expected option grants in the future, and the potential personal gains of additional acquisitions are relatively certain. Given these three factors, CEOs will be more willing to accumulate stock options after having their compensation rebalanced. 2.3 The political perspective Politically, CEOs who have recently completed an acquisition that resulted in a loss for the company will be weakened and in an unfavorable position to pursue further acquisitions for fear of dismissal if the future acquisition goes poorly (Finkelstein 1992; Lehn and Zhao 2006). It has previously been established that weakened CEOs have difficulty negotiating compensation protection devices (Bodolica and Spraggon 2009). In this regard, weakened CEOs are also unlikely to be able to directly renegotiate compensation packages which restore their risk-seeking incentives, i.e. stock options, especially after the board of directors has just intentionally reduced those incentives. Although CEOs are capable of selling existing unrestricted stock holdings to offset the new restricted stock grants, doing so is informally discouraged (Gogoi 1999; Kay 1999) and is also symbolically unfavorable, as discussed in the following section. Unlike renegotiation or selling stock holdings, refraining from exercising stock options may be a politically acceptable course of action available to the CEO. By not directly protesting compensation rebalancing, retaining stock options would appear to indicate greater alignment between the incentives of the CEO, the directors, and the shareholders (Larcker 1983; Westphal and Zajac 1998). Not protesting restricted stock holdings may also lend the CEO more credibility and thus enhance his or her political power to pursue subsequent decisions (Cannella and Shen 2001; Finkelstein 1992; Hambrick and Finkelstein 1995; Westphal and Zajac 1995; Zajac and Westphal 1996), including future acquisitions.
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2.4 The symbolic perspective From the symbolic perspective, the loss of shareholder value stemming from a poorly performing acquisition, coupled with the personal gains of the CEO from undertaking the acquisition, offers shareholders evidence that the CEO may not be acting in the shareholders’ best interests (Grinstein and Hribar 2004; Harford and Li 2007; Lee et al. 2009). At the same time, a poorly performing acquisition also offers evidence that the directors may not be effectively monitoring the CEO. As a result, the board of directors will wish to take visible action to assure shareholders of management’s commitment to the firm, like the removal of compensation protection devices (Bodolica and Spraggon 2009). In this frame, adjusting CEO compensation packages to include stock in lieu of stock options is a signal to shareholders that directors are aware of an agency problem and have ‘‘punished’’ the CEO in such a way as to guard against the pursuit of additional overly optimistic acquisitions. Although the CEO has strong incentives to return his or her compensation portfolio to its earlier risk-encouraging state, direct solutions like selling shares of stock or renegotiating compensation packages to include less stock and more stock options are likely to send a negative signal to directors and investors. These actions would send a signal that the CEO wishes to insulate his or her wealth from future losses in firm value and is less confident in future firm performance. Consequently, these responses to compensation rebalancing will be discouraged and, if pursued anyway, will give the directors reason to doubt the CEO’s ability to create value from additional acquisitions. However, if the CEO refrains from exercising stock options and instead accumulates option holdings it can send a signal to both directors and shareholders that the CEO is investing more of his or her personal wealth in the future performance of the company and is confident of its performance (Westphal and Zajac 1994, 1995, 1998). Particularly following a period in which the directors believe the CEO to hold too few shares of restricted stock, this act reassures both shareholders and directors that the CEO is committed to ensuring that subsequent strategic decisions enhance firm value and gives the CEO more credibility and discretion when pursuing subsequent strategic decisions, such as future acquisitions. As mentioned earlier, both the hubris literature (Brown and Sarma 2007; Malmendier and Tate 2005, 2008) and the agency theory literature (Jensen and Murphy 1990) argue that it is possible for a CEO to be overinvested in the firm. However, it is important to note that compensation rebalancing involves both a reduction in stock option awards but also an increase in restricted stock grants. Directors that feel their executives are already over-invested in the firm are more likely to reduce both option and stock awards than to replace options with restricted stock. Therefore, it is likely that directors that engage in compensation rebalancing do not view their CEOs as over-invested in the firm and will not view additional holdings as a negative signal. Furthermore, the alternative solutions of renegotiation or the sale of shares of stock still send strong negative signals that the CEO is undermining the direct efforts of the board to rebalance their compensation package. Accumulating options could ambiguously signal overconfidence. However, given the balance between a strong negative signal and an ambiguous signal, we argue that
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the directors will be more averse to the strong negative signal of underinvestment in shares of restricted stock than the ambiguous signal of potential overconfidence in larger stock option holdings. 2.5 Hypotheses Combining our discussion across these three perspectives, this research proposes that CEOs are likely to respond to compensation rebalancing by exercising fewer stock options and thus accumulating stock option holdings. This conjecture contains three individual parts. First, in line with Spraggon and Bodolica (2011), we examine whether CEOs typically have their compensation rebalanced during a period of poor firm performance following an acquisition. Second, we propose that CEOs will respond to this board induced rebalancing by exercising fewer stock options as a countermove. Third, we conjecture that CEOs will exercise fewer stock options to increase, as opposed to simply maintain, their overall option holdings within their compensation portfolio. As argued by Spraggon and Bodolica (2011), compensation rebalancing is a mechanism the board of directors frequently employs to ‘punish’ the CEO for poor firm performance following an acquisition. Following an acquisition that has performed poorly, the board of directors may become concerned that the CEO’s personal incentives for pursuing acquisitions are too large and leading to inefficient acquisitions thereby lowering the performance of the firm. Since stock options encourage CEOs to make riskier decisions, the board of directors will renegotiate the CEO’s annual compensation package and replace option-based compensation with stock-based compensation. Rebalancing the CEO’s compensation package in this way lessens the option-based incentives to pursue risky decisions and adds additional stock-based penalties for decisions, like acquisitions, that lead to poor firm performance. Therefore, we first expect the following: Hypothesis 1: Following an acquisition, poor firm performance will be associated with CEO compensation rebalancing. Specifically, CEO compensation packages will be adjusted to include more restricted stock and fewer stock option grants. After their compensation has been rebalanced, CEOs will respond by exercising fewer stock options. Refraining or reducing the number of stock options the CEO exercises each year allows the CEO to accumulate greater overall holdings of stock options even when new option grants have been reduced by the board of directors. It is not theoretically distinguishable a priori whether CEOs will fully eliminate or simply reduce the number of stock options they exercise, but it is clear that, in order to accumulate total holdings of stock options via restraint, the CEO would need to exercise fewer than he or she has before his or her annual compensation package was rebalanced. Hypothesis 2: Following compensation rebalancing, CEOs will exercise fewer stock options. Compensation rebalancing includes a reduction in stock options grants. Therefore, even without risk incentives, CEOs that exercise a constant percent of
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their stock option grants would be expected to exercise fewer stock options following a reduction in new grants from compensation rebalancing. However, compensation rebalancing also includes additional restricted stock that increases the disincentives to pursue risky decisions, like acquisitions. To outweigh the additional stock-based disincentives, the CEO needs larger overall stock option holdings to create additional risk-encouraging incentives.4 Therefore, CEOs will not exercise fewer stock options simply because they are granted fewer stock options each year. They will strive to enlarge total stock option holdings despite a reduction in the number of stock options granted each year. Hypothesis 3: Following compensation rebalancing, the total number of stock options held by the CEO will increase.
3 Methods 3.1 Sample To describe how CEOs manage their stock options following an acquisition, this paper examines the compensation management of the CEOs of publicly traded U.S. firms listed in the Standard & Poor’s 500, Mid-Cap 600, and Small-Cap 400 indexes that completed at least one acquisition from 1992 to 2013. These CEOs are chosen because the firms of these CEOs are required to disclose data on the compensation of their top executives and their acquisition activity, as collected in the Execucomp database. This data includes cash salary, cash bonuses, stock and stock option grants, and total stock and option holdings. Acquisitions are identified from regulatory disclosures, as collected in the Security Data Company’s (SDC) M&A database. Since this study examines post-acquisition compensation behavior, the date of the acquisition execution rather than its announcement is used as the acquisition date and acquisitions that were announced but not completed are excluded from the sample. Using the date of the acquisition execution in lieu of the acquisition announcement is important because the compensation effects studied here, including completion bonuses and compensation rebalancing, typically occur following the completion of the acquisition, not the more commonly studied announcement of the acquisition. Stock prices are collected from the Center for Research in Security Prices (CRSP) database and additional accounting data is collected from the Compustat database. These datasets are matched yearly using the 6-digit CUSIP of the firm employing the CEO. In line with prior research, yearly totals are aggregated (Ofek and Yermack 2000). When a database reports individual equity issues, like stock prices, at the 8-digit CUSIP level, the largest traded equity issue is used. To ensure that the CEOs in the sample represent individuals who recently completed an acquisition, and are therefore at risk of having their compensation 4
It is not theoretically clear exactly how many additional stock options are needed to offset additional restricted stock. However, it is theoretically tenable that more shares of stock will result in greater riskdiscouraging effects, and additional options would be necessary to create a greater risk-encouraging incentive.
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packages renegotiated post-acquisition, the sample is limited to CEOs that have completed at least one acquisition in the last 3 years. This sample does not exclude CEOs who have made subsequent acquisitions. Frequent acquisition behavior may be the result of CEO overconfidence (Roll 1986) or learning (Aktas et al. 2009, 2011). As mentioned earlier, either confidence or overconfidence may provide CEOs with a motivation to refrain from exercising stock and option holdings independent of any compensation rebalancing effects. Yet, restructuring the incentives of serial acquiring CEOs to prevent subsequent poorly performing acquisitions is of key interest to directors. As a consequence, we do not exclude frequent acquirers from our sample. Because our research questions concern the post-acquisition behavior of CEOs, our sample is necessarily limited to CEOs that have completed an acquisition. However, the decision to acquire can be an endogenous one. To ensure that sample bias is not driving our results, we repeat all of our analyses using a two-stage Heckman (1979) approach in which we first estimate the probability of acquisition and include that probability as a control variable in our regressions. In total, our sample includes 3592 acquiring CEOs employed by 2282 firms and 1093 non-acquiring CEOs employed by an additional 420 firms over the years 1992–2013.5 3.2 Dependent variables Since this study predicts that boards will respond to poorly performing acquisitions by rebalancing the CEO’s compensation package and that CEOs will refrain or reduce their exercise of stock options to increase their overall option holdings, four dependent variables are used. 3.2.1 Compensation rebalancing Compensation rebalancing is examined as a dependent variable within our analysis of how the board of directors responds to poor firm performance following an acquisition. Our first hypothesis predicts that following an acquisition, poor firm performance will be associated with CEO compensation rebalancing. The compensation rebalancing variable captures whether the CEO has had option-based compensation replaced by restricted stock during the year of the acquisition. This variable is binary. It takes on a value of one if the CEO’s annual stock option grants are less than in the previous year and the CEO’s annual restricted stock grants are greater than in the previous year and zero otherwise. 3.2.2 Change in percent of options exercised A CEO wishing to accumulate stock option holdings can do so by reducing the number of options exercised. Therefore, one of the key dependent variables in this 5
Each observation may not be complete. The procedure for handling incomplete observations is described at the end of the description of the variables.
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study is the change in the portion of a CEO’s stock options that are exercised. This variable is defined as the proportion of total stock options the CEO exercises in a given year divided by the proportion of total stock options that the CEO exercised in the previous year. Defining this variable as the year-to-year change reduces the influence of possible fixed effects which may include time-invariant and/or difficult to measure personal characteristics, such as personal risk preferences. Additionally, both restricted and unrestricted stock options are included when computing total stock option holdings. Although CEOs are unlikely to be able to exercise new restricted option grants, they can exercise unrestricted option holdings to balance new restricted options, similar to how CEOs have been observed to exercise unrestricted stock to balance new restricted stock grants (Jin and Kothari 2008; Ofek and Yermack 2000). Furthermore, both restricted and unrestricted options limit losses and encourage more risky decision making, such as engaging in more frequent acquisitions. However, as a percent change this measure is undefined for CEOs which do not exercise any stock options, of which there are many. These cases are accounted for in the following binary variable to avoid biasing the results of our analysis. As will be shown, our results hold for both variable definitions. 3.2.3 CEO exercises any options At the extreme, a CEO wishing to reduce option exercise can choose to exercise no options. In practice, this phenomenon is quite common. In this sample, CEOs chose not to exercise any stock options 56 % of the time. Not including this dependent variable in the analysis would potentially bias the analysis by excluding these CEOs from the sample. Therefore, this binary variable is included which takes on a value of one if the CEO exercises any stock options in a given year and zero otherwise. 3.2.4 Change in number of options held This study predicts that CEOs will reduce option exercise for the purpose of increasing overall option holdings. To measure the overall increase in option holdings we examine the percent change in the CEO’s overall option holdings, defined as the percent increase in the total number of options held relative to the previous year. Additionally, this variable is also defined as the year-to-year relative change and the total number of options held, including both restricted and unrestricted options for the same reasons described earlier. 3.3 Independent variables 3.3.1 Compensation rebalancing In addition to being explored as a dependent variable, compensation rebalancing is also included within our analyses as an independent variable to examine how CEOs respond to rebalanced compensation. Specifically, our second and third hypotheses predict that CEOs will adjust how they manage their stock options following a rebalancing of their compensation. As discussed, this variable is binary. It takes on a
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value of one if the CEO’s option-based compensation is less than it was in the previous year and zero if the CEO’s stock-based compensation is greater than it was in the previous year. 3.3.2 Adjusted stock returns Industry adjusted stock market returns of recent acquisitions are used to identify whether the last acquisition performed well or poorly. These are defined as the stock market returns in the year of the most recent prior acquisition or acquisitions, adjusted for dividends, stock splits, and industries.6 Since the compensation data is annual and CEOs frequently make multiple acquisitions in a year, the data cannot identify specifically which acquisition caused the compensation rebalancing. Therefore, the choice of measuring returns over the entire year encompasses all of the acquisitions that may have been included in the rebalancing decision. Results are robust to the use of unadjusted stock returns as well. 3.3.3 Average stock option value The value of the stock options is also likely to influence exercise behavior. Behavioral theory argues that CEOs wish to reduce their wealth exposure. Therefore, options with a higher value represent greater personal wealth at risk and are more likely to be exercised (McGuire and Matta 2003). Conversely, options with lower value represent less wealth risk and are more likely to be retained. We argue that CEOs have an incentive to accumulate options beyond these risk effects. Therefore the overall average value of each stock option is also included as a control. The total value of stock options is a reported value, defined as their Black and Scholes (1973) computed value. We divide this total value by the total number of options held to find the average option value. 3.4 Controls Other factors may also influence how CEOs actively manage the risk-incentives of their compensation portfolio, including the total number of stock options, the number of new options granted, and the percent of annual compensation in the form of stock options. The percent of compensation in the form of stock options is defined as the value of the stock options granted divided by the total value of the stock options, restricted stock, and cash compensation awarded that year. This measure captures the relative portion of the CEO’s compensation issued in the form of stock options. Additionally, firm size has been linked to both the overall size and composition of CEO compensation (Bliss and Rosen 2001; Schmidt and Fowler 1990; Tosi et al. 2000). As such, the present study controls for firm size using the company’s total assets. Results are robust to the alternative definition of total sales as well. In our first-stage estimation, we also control for the number of previous acquisitions as a measure of a CEO’s individual propensity to acquire and a strong 6
Defined according to 4-digit SIC codes.
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predictor of future acquisitions. This control is also robust to alternate specifications including total value of completed acquisitions and total value of completed acquisitions relative to firm size. Lastly, in recent years stock option compensation has been increasingly favored over cash compensation. To control for any temporal effects, dummy variables for each year are included. 3.5 Instrumental variable In our first-stage estimation, we include the number of previous acquisitions, as our instrumental variable. Ideally, an instrumental variable should be strongly correlated with the selection variable, but not with the original dependent variables. Extensive prior research on CEO overconfidence has established a link between past acquisition frequency and the propensity to acquire (e.g.,: Doukas and Petmezas 2007; Finkelstein and Haleblian 2002; Haleblian and Finkelstein 1999; Haleblian et al. 2006). However, the number of previous acquisitions should have no relationship to the likelihood that a CEO will exercise stock options beyond changes in compensation structure, which we already control for directly, and the likelihood of future acquisitions. 3.6 Handling of data All of the non-binary variables, except for adjusted stock market returns, are found to be log-normally distributed and log-transformed during analysis to avoid biasing coefficients with excessive distributional tails. Because data is combined from multiple sources, it is possible although not common for a CEO or the employing firm to be in one dataset but not another. Rather than lose the unmatched data, missing values are filled in with the mean of the non-missing observations. When data are interpolated in this way, a dummy variable to identify the interpolated data is also included. This procedure allows for the inclusion of the partially matched data while preventing the interpolations from biasing results. These dummy variables are not shown to conserve space. The interpolated observations are excluded from observation counts reported in our descriptive statistics.
4 Results 4.1 Descriptive statistics Table 1 reports the means, standard deviations, and correlation coefficients of the variables. All of the continuous variables, except stock returns, are log-normally distributed. Therefore these variables are reported as the log of their values. In general, compensation rebalancing is relatively infrequent, occurring in roughly 13 % of the observations. Furthermore, CEOs in the sample exercised stock options 43 % of the time, typically increased their exercise by 14 % when they did, and their overall stock option holdings decrease on average by 4 % year-to-year.
123
Change in number of options held (log)
CEO has compensation rebalanced
Adjusted stock returns
Log of average option value
Log of percent of compensation issued as stock options
Log of number of new option grants
Log of total number of options held
Log of percent change in new option grants
Log of total assets
2
3
4
5
6
7
8
9
10
11
16,136
14,724
12,503
12,497
14,455
16,212
16,169
16,212
14,422
3959
16,169
N
1.49
1.90
0.00
0.00
0.18
-0.02
0.00
0.13
0.00
0.14
0.42
Mean
1.42
1.21
0.36
0.15
0.38
0.36
0.15
0.34
2.33
1.23
0.49
SD
0.29
0.32
0.09
0.04
-0.06
0.10
0.04
-0.05
-0.11
–
1.00
1
1.00
0.01
0.09
-0.02
0.00
-0.04
0.03
-0.03
-0.04
-0.20
2
1.00
0.10
-0.04
0.02
0.01
0.06
0.02
0.00
-0.02
3
1.00
0.01
0.00
0.03
0.03
-0.03
-0.01
-0.01
4
0.10
0.14
0.07
0.01
0.00
0.41
1.00
5
0.20
0.31
0.51
0.19
0.02
1.00
6
0.03
0.06
1.00
-0.04
-0.02
7
0.07
0.08
0.42
1.00
8
0.15
0.21
1.00
9
0.69
1.00
10
1.00
11
Sample includes only CEOs that completed an acquisition
Correlations larger than 0.02 are significant at p \ 0.05. Correlations larger than 0.03 are significant at p \ 0.01. (Expect for variable 2 for which 0.04 is significant at p \ 0.05 and 0.06 is significant at p \ 0.01)
CEO exercises any options (binary)
Change in percent of options exercised (log)
1
Variable
Table 1 Descriptive statistics and correlations
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The correlation between the binary variable if the CEO exercises any stock options and the change in the percent of options exercised is impossible to calculate due to their defined, overlapping relationship. There is a measurable degree of correlation between some of the control variables included within the analysis such as between average option value, number of new option grants, and total number of options held. Some of these correlations are substantial with coefficient magnitudes greater than 0.20. There is also some degree of correlation between two of our dependent variables, change in percent of options exercised and change in number of options held (-0.21). However there is minimal correlation between our hypothesis testing variable, compensation rebalancing, and our other independent and control variables. Therefore, these correlations should not bias our hypotheses tests. As an additional caution, we report only robust standard errors. Furthermore, if multicollinearity were substantially impacting the estimation of coefficients, we would expect to observe very high standard errors in our models. In none of our models are any of our variable standard errors larger than the regression constant. Moreover, we computed variance inflation factors (VIFs) for our independent variables. None of the VIFs were greater than 4, well under the benchmark for concern of 10. Thus, multicollinearity, if it exists, should not be influencing our estimation. Nonetheless, as we discuss in our limitations, we do strongly caution the reader from interpreting coefficients from our correlated control variables. 4.2 Tests of hypotheses To robustly examine our theoretical queries, we now examine the three study hypothesis in turn. First, we examine whether compensation balancing is most prominent as a reaction to poor firm performance surrounding an acquisition per hypothesis 1. Next, we test whether CEOs exercise fewer options following a replacement of their option-based compensation with stock-based compensation per hypothesis 2. Finally, we examine whether the reduction in exercise serves to increase, rather than simply maintain, their overall level of option holdings per hypothesis 3. 4.2.1 Replacement of compensation and firm performance Hypothesis 1 proposes that boards will rebalance the CEO’s compensation following poor firm performance associated with an acquisition. Since it is not theoretically clear how quickly the board responds, we examine the percent of CEOs whose compensation is rebalanced relative to when their last acquisition occurred. Separate percentages are computed for CEOs whose firms had positive industry-adjusted stock market returns during their last acquisition year and for CEOs whose firms had negative returns and are displayed in Fig. 1. Two characteristics are evident. First, the replacement of compensation occurs contemporaneously with acquisitions. CEOs whose compensation is rebalanced find that the rebalancing happens within the same year as the acquisition and very few CEOs have their compensation packages rebalanced after the first year following an acquisition. Second, contrary to hypothesis 1, there is no significant difference in the
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.05
.1
.15
.2
Frequency of Compensation Rebalancing
0
Percent of CEOs who have Options Replaced with Stock
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0
1
2
Years Since Most Recent Acquisition Well Performing Acquisitions
Poorly Performing Acquisitions
Fig. 1 Frequency of compensation rebalancing
adoption of rebalancing plans among CEOs whose firms enjoyed positive industryadjusted stock returns during the acquisition year and CEOs whose firms experienced negative returns (18.2 vs. 18.7 %, p = 0.47). In contrast to Spraggon and Bodolica (2011), this study finds the likelihood that a CEO will have his or her compensation rebalanced is nearly equal among acquiring firms that performed well and poorly. We will return to this finding within the discussion. 4.2.2 Reduction in option exercise Two models are used to test hypothesis 2, that the CEO will reduce his or her stock option exercise. In the first, shown in Table 2, the change in the percent of total options exercised is regressed against the percent of total options exercised and a number of controls including changes in compensation, firm size, and yearly dummy variables. The binary variable capturing compensation rebalancing during the year of the last acquisition is added incrementally. Since it is theoretically unclear how quickly the CEO will react to this replacement in compensation, this process is performed separately assuming that the CEO responds in the year of and again for the year following the compensation readjustment. The coefficient of the binary variable for the presence of compensation rebalancing is negative and significant in the concurrent model (-0.33, p \ 0.05) but not in the delayed model. When facing compensation rebalancing, CEOs on average exercise 33 % fewer options, indicating support for the second hypothesis. Notably, in addition to statistical significance, the addition of the rebalancing variable results in a statistically significant improvement in the overall fit of the concurrent model (F = 4.28, p \ 0.01). To account for the possibility of selection bias, we also use a Heckman (1979) correction model displayed in Table 3. In the first stage, we estimate the probability that a CEO will engage in at least one acquisition using a number of controls including the number of past acquisitions, firm size, and the compensation variables in our second stage estimation. In the second stage, we estimate the percent of total
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J. S. Marsh et al. Table 2 Results of linear regression of percent change in CEO stock option exercise Variables
Year of rebalancing
Rebalancing
Year after rebalancing
-0.33**
-0.07
(0.14) 0.25***
(0.06)
Adjusted stock returns
0.24***
-0.10
-0.10
(0.07)
(0.07)
(0.06)
(0.06)
Average value of each stock option (log)
0.02
0.02
0.08**
0.08**
(0.03)
(0.03)
(0.03)
(0.03)
Percent of compensation in form of stock options (log)
0.03
0.03
0.03
0.03
(0.03)
(0.03)
(0.03)
(0.03)
Total number of options held (log)
-0.08***
-0.07***
-0.07***
-0.08***
New stock options (log)
(0.03)
(0.03)
(0.03)
(0.03)
0.00
-0.00
0.01
0.01
(0.01)
(0.01)
(0.01)
(0.01)
Firm size (log of total assets)
0.02*
0.02*
0.01
0.01
(0.01)
(0.01)
(0.01)
(0.01)
Constant
0.53
0.50
0.77**
0.83**
(0.35)
(0.34)
(0.34)
(0.34)
N
3846
3846
3816
3816
Adjusted R-squared
0.0173
0.0184
0.0140
0.0141
F-statistic of improvement in R-squared F-statistic of overall model fit
4.28*** 3.566***
3.832***
0.39 3.150***
3.055***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
options exercised against the same controls in our previous single-stage model. Again, compensation rebalancing is added incrementally. Similarly, we find that compensation rebalancing is negative and significant in the concurrent model (-0.33, p \ 0.05) but not in the delayed model. Furthermore, we do not find evidence of sample selection in the change in CEO stock option exercise. The Chi square for the Heckman correction is not significant at the 10 % level. However, the inclusion of the rebalancing variable again improves overall model fit (F = 5.09 and F = 1.55, p \ 0.01 and p \ 0.05). The above model includes only CEOs that exercised stock options. To include CEOs who did not exercise any stock options, Table 4 show coefficients from probit regressions of whether or not the CEO exercises any stock options are fitted against compensation rebalancing and a number of controls including changes in compensation, firm size, and yearly dummy variables. The coefficient on our compensation rebalancing binary variable is negative and significant in both the concurrent (-0.17, p \ 0.01) and in the delayed model (-0.22, p \ 0.01). This result offers support that CEOs whose compensation has been rebalanced are less likely than normal to exercise any options. To assess model fit, we compute
123
Second stage
3846 18,486
Non-acquiring firm-year observations
(0.38)
(0.16)
(0.16)
18,486
3846
(0.37)
1.12***
(0.06)
1.16***
-2.09***
-2.09***
(0.01)
(0.06)
(0.01)
0.02
(0.01)
-0.01
(0.03)
-0.08***
(0.03)
0.03
(0.04)
-0.00
(0.07)
-0.08
(0.01)
(0.01)
0.02**
(0.01)
0.06***
(0.01)
-0.02
(0.02)
0.00
(0.02)
0.32***
(0.03)
0.27***
(0.16)
-2.15***
(0.01)
0.03***
(0.01)
0.05***
(0.01)
-0.02
(0.02)
-0.00
(0.02)
0.27***
(0.03)
0.20***
(0.01)
0.47***
18,129
3816
(0.38)
1.08***
(0.06)
-0.06
(0.01)
0.01
(0.01)
0.00
(0.03)
-0.08***
(0.03)
0.03
(0.03)
0.06*
(0.06)
-0.11*
(0.16)
-2.15***
(0.01)
0.03***
(0.01)
0.05***
(0.01)
-0.02
(0.02)
-0.00
(0.02)
0.27***
(0.03)
0.20***
(0.01)
0.47***
18,129
3816
(0.38)
1.08***
(0.06)
-0.05
(0.01)
0.01
(0.01)
0.00
(0.03)
-0.08***
(0.03)
0.03
(0.03)
0.07*
(0.06)
-0.10*
(0.06)
-0.08
0.02
(0.01)
(0.01) 0.02**
-0.00
(0.03)
0.06***
-0.08***
(0.01)
(0.03)
(0.02) -0.02
0.03
(0.04)
(0.02) 0.00
0.00
0.32***
(0.07)
(0.03)
-0.26***
(0.01) 0.27***
(0.01) -0.26***
0.47***
0.47***
-0.06
Second stage
(0.14)
First stage
-0.33**
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s Lambda
Firm size (log of total assets)
New stock options (log)
Total number of options held (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 3 Results of Heckman linear regression of percent change in CEO stock option exercise
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123 Second stage
(0.178)
(0.170)
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
1.815
1.880
Chi squared for Heckman correction
0.0237 5.09***
0.0224
(0.283)
1.152
0.0193
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
F-statistics of improvement in R-squared
Adjusted R-squared
Variables
Table 3 continued
First stage
(0.393)
0.730
1.55**
0.0197
Second stage
J. S. Marsh et al.
Countermove: how CEOs respond to post-acquisition… Table 4 Results of probit regression of if CEO exercises stock options Variables
Year of rebalancing
Rebalancing
Year after rebalancing
-0.17***
-0.22***
(0.03) -0.09*** (0.03)
(0.03)
(0.03)
(0.03)
Average value of each stock option (log)
0.38***
0.37***
0.34***
0.34***
Percent of compensation in form of stock options (log) Total number of options held (log) New stock options (log)
-0.09***
(0.03)
Adjusted stock returns
0.21***
0.22***
(0.02)
(0.02)
(0.02)
(0.02)
0.00
0.01
0.01
0.01
(0.01)
(0.01)
(0.02)
(0.02)
0.04***
0.04***
0.02
0.02
(0.01)
(0.01)
(0.01)
(0.01)
0.03***
0.03***
0.04***
0.04***
(0.01)
(0.01)
(0.01)
(0.01)
Firm size (log of total assets)
0.03***
0.03***
0.04***
0.04***
(0.01)
(0.01)
(0.01)
(0.01)
Constant
-1.76***
-1.70***
-1.61***
-1.50***
(0.16)
(0.16)
(0.17)
(0.17)
N
14,469
14,469
12,868
12,868
McFadden’s adjusted pseudo R-square
0.092
0.096
0.098
0.100
Chi square likelihood ratio test for improvement in fit
24.30***
46.17***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
McFadden’s adjusted pseudo R-squares (McFadden 1974). To test for improvement in model fit, we compute a Chi square distributed likelihood ratio test. In both models, addition of rebalancing improves overall fit (Chi square 24.30 and 46.17, both p \ 0.01). Like our first hypothesis test, we also use a Heckman (1979) correction model displayed in Table 5. As in Table 3, we estimate the probability that a CEO will engage in at least one acquisition in the first stage. In the second stage, we regress whether or not the CEO exercises any stock options against the same controls in our previous single-stage model. Again, compensation rebalancing is added incrementally. After using the Heckman correction for possible sample selection, our rebalancing variable is only significant in the delayed model (-0.16, p \ 0.01). Notably, in this case sample selection does appear to be an issue. The Chi squared values for the Heckman correction are significant beyond the 1 % level regardless of specification. Similar to Table 4, we also compute McFadden adjusted r-squares for each model. Only in the significant delayed model does compensation rebalancing improve model fit (Chi square 22.6, p \ 0.01).
123
123 Second stage
9330 0.043
Non-acquiring firm-year observations
McFadden’s adjusted pseudo R-square
(0.17)
(0.14) 13,002
-1.40***
-0.43*** (0.14)
-0.43***
0.043
9330
13,002
(0.17)
-1.40***
(0.03)
(0.03)
(0.01)
0.03***
(0.01)
0.04***
(0.01)
0.02
(0.02)
0.01
(0.02)
0.37***
(0.03)
-0.20***
(0.01)
-0.00
(0.01)
0.04***
(0.01)
-0.04***
(0.02)
0.03*
(0.02)
0.05***
(0.02)
-0.08**
(0.14)
-0.44***
(0.01)
0.00
(0.01)
0.04***
(0.01)
-0.04***
(0.02)
0.02
(0.02)
0.02
(0.02)
-0.01
(0.03)
1.55***
0.045
9077
12,868
(0.17)
-1.39***
(0.03)
-0.23***
(0.01)
0.04***
(0.01)
0.04***
(0.01)
0.02
(0.02)
0.00
(0.02)
0.34***
(0.03)
0.23***
(0.14)
-0.44***
(0.01)
0.00
(0.01)
0.04***
(0.01)
-0.04***
(0.02)
0.02
(0.02)
0.02
(0.02)
-0.01
(0.03)
1.55***
0.046
9077
12,868
(0.17)
-1.35***
(0.03)
-0.18***
(0.01)
0.04***
(0.01)
0.04***
(0.01)
0.01
(0.02)
0.01
(0.02)
0.34***
(0.03)
0.23***
(0.03)
-0.20***
(0.01)
(0.01)
(0.01) 0.03***
(0.01)
-0.00
0.04***
(0.01)
(0.01)
0.04***
0.02
(0.02)
(0.02)
-0.04***
0.01
(0.02)
(0.02)
0.03*
0.37***
0.05***
(0.03)
(0.02)
-0.15***
(0.03) -0.08**
(0.03)
-0.15***
1.56***
1.56***
-0.16***
second stage
(0.08)
First stage
-0.02
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s lambda
Firm size (log of total assets)
New stock options (log)
Total number of options held (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 5 Results of heckman probit regression of if CEO exercises stock options
J. S. Marsh et al.
Second stage
48.83*** (0.00)
48.93*** (0.00)
Chi squared for Heckman correction
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
0.06
(0.00)
58.72***
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Chi square likelihood ratio test for improvement in fit
Variables
Table 5 continued
First stage
(0.00)
35.78***
22.6***
second stage
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4.2.3 Increase in total option holdings To test that the reduction in option exercise is designed to increase the overall option holdings of the CEO per hypothesis 3, and not just maintain pre-rebalancing levels, the change in the total number of options held by the CEO is regressed against a number of controls including changes in compensation, firm size, and yearly dummy variables. Results of this analysis are shown in Table 6. Again, the binary variable of compensation rebalancing is added incrementally. Supporting the hypothesis, compensation rebalancing is positive and significant in both the concurrent (0.35, p \ 0.01) and delayed (0.21, p \ 0.01) models. This result indicates that following compensation rebalancing CEOs’ total option holdings grow on average 35 % in the year of the rebalancing and 21 % in the year following rebalancing relative to their non-rebalanced peers despite a reduction in new option grants. The inclusion of the rebalancing variable improved the overall fit of both models (F = 13.67 and 33.82, both p \ 0.01). Like the previous two hypothesis tests, we also use a Heckman (1979) correction model displayed in Table 7. As in Tables 3 and 5, we estimate the probability that a CEO will engage in at least one acquisition in the first stage. In the second stage, we Table 6 Results of linear regression of percent change in CEO stock option holdings Variables
Year of rebalancing
Rebalancing
Year after rebalancing
0.35***
0.21***
(0.07) 0.13*** (0.04)
(0.04)
(0.04)
(0.04)
Average value of each stock option (log)
-0.08***
-0.08***
-0.08***
-0.08***
(0.02)
(0.02)
(0.02)
(0.02)
Percent of compensation in form of stock options (log)
-0.01
-0.01
-0.01
-0.00
(0.02)
(0.02)
(0.02)
(0.02)
New stock options (log)
-0.00
0.00
0.00
0.00
(0.01)
(0.01)
(0.01)
(0.01) 0.12***
Percent change in stock option grants (log)
0.13***
(0.04)
Adjusted stock returns
0.10***
0.09**
0.13***
0.14***
0.12***
(0.01)
(0.01)
(0.01)
(0.01)
Firm size (log of total assets)
0.00
0.00
0.00
0.00
(0.01)
(0.01)
(0.01)
(0.01)
Constant
0.70***
0.70***
0.37***
0.23**
(0.12)
(0.12)
(0.09)
(0.09)
N
13,001
13,001
12,868
12,868
Adjusted R-squared
0.050
0.051
0.048
0.051
F-statistic of improvement in R-squared F-statistic of overall model fit
13.67*** 11.74***
11.38***
33.82*** 11.12***
10.94***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
123
Second Stage
9331
Non-acquiring firm-year observations
(0.10)
(0.15) 13,001
0.21**
-0.69***
(0.15)
-0.69***
9331
13,001
(0.10)
0.21**
(0.03)
(0.01)
(0.04)
(0.01)
0.01
(0.01)
0.14***
(0.01)
0.00
(0.02)
-0.00
(0.02)
-0.08***
(0.04)
0.12***
(0.01)
(0.01)
-0.00
(0.01)
0.03***
(0.01)
-0.02*
(0.02)
0.02
(0.02)
0.05***
(0.03)
0.11***
(0.15)
-0.71***
(0.01)
0.00
(0.01)
0.03***
(0.01)
-0.02*
(0.02)
0.01
(0.02)
0.03**
(0.03)
0.01
(0.03)
1.57***
9077
12,868
(0.10)
0.23**
(0.04)
0.11***
(0.01)
0.01
(0.01)
0.12***
(0.01)
0.00
(0.02)
-0.00
(0.02)
-0.07***
(0.04)
0.09**
(0.15)
-0.70***
(0.01)
0.00
(0.01)
0.03***
(0.01)
-0.02**
(0.02)
0.01
(0.02)
0.03**
(0.03)
0.01
(0.03)
1.57***
9077
12,868
(0.09)
0.25***
(0.02)
0.05**
(0.01)
0.01
(0.01)
0.12***
(0.01)
0.00
(0.02)
-0.00
(0.02)
-0.07***
(0.04)
0.08**
(0.05)
0.13***
0.01
-0.00
(0.01)
(0.01)
(0.01) 0.13***
(0.01) 0.03***
0.00
(0.02)
-0.02*
0.00
0.02
(0.02)
(0.02) (0.02)
-0.08***
0.05***
(0.04)
(0.03)
-0.12***
(0.03) 0.12***
(0.03) -0.12***
1.58***
1.58***
0.18***
Second Stage
(0.07)
First Stage
0.34***
Second Stage
First Stage
First Stage
First Stage
Second Stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s Lambda
Firm size (log of total assets)
Percent change in stock option grants (log)
New stock options (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 7 Results of Heckman linear regression of percent change in CEO stock option holdings
Countermove: how CEOs respond to post-acquisition…
123
123 Second Stage
(0.00)
(0.00)
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
13.35***
12.83***
Chi squared for Heckman correction
0.051 15.04***
0.050
(0.01)
6.718***
0.049
Second Stage
First Stage
First Stage
First Stage
Second Stage
Year after rebalancing
Year of rebalancing
F-statistic of improvement in R-squared
Adjusted R-squared
Variables
Table 7 continued
First Stage
(0.04)
4.022***
35.20***
0.052
Second Stage
J. S. Marsh et al.
Countermove: how CEOs respond to post-acquisition…
regress overall CEO option holdings against the same controls in our previous single-stage model. Again, compensation rebalancing is added incrementally. Again, we find strong evidence for sample selection issues (p \ 0.05 in all models), but our results hold. In both Heckman models, compensation rebalancing is associated with an increase in stock option holdings (0.34, p \ 0.01 in year of rebalancing and 0.18, p \ 0.01 in year following rebalancing). Again, the rebalancing variable improves overall model fit (F—15.04, 35.02, both p \ 0.01). As a robustness check, we repeat our analyses excluding a randomly selected 20 % of the data. Across several iterations, our results remain consistent offering evidence that our results are due to a consistent pattern and not due to a couple outlying observations. These additional tables are not shown to conserve space.
5 Discussion This study set out to examine how CEOs respond to compensation rebalancing. Prior work has suggested that following poorly performing acquisitions, boards ‘‘punish’’ the CEO by redesigning the CEO’s annual compensation package to include fewer risk-inducing stock options and more risk-discouraging shares of stock (Spraggon and Bodolica 2011). However, this paper proposes a countermove whereby CEOs who wish to retain the risk-seeking properties of stock options can increase their overall option holdings by delaying exercising existing stock options. Furthermore, this countermove is motivated by a multi-theory perspective and represents a way in which the CEO can rebalance his or her own compensation without intervention from the board of directors. It preserves the economic riskincentives of the CEO’s compensation portfolio by offsetting additional riskdiscouraging restricted stock grants with increases in risk-encouraging stock option holdings. It also remains politically and symbolically agreeable to directors and shareholders as delaying stock option exercise is seen as a positive expectation of future performance and commitment by the CEO. Consistent with this argument, this study finds evidence that CEOs on average are less likely to exercise options, exercise 33 % fewer options when they do, and increase their overall level of option holdings between 21 and 35 % following a replacement of option-based compensation with stock-based compensation. However, contrary to expectations, this study does not find a relationship between poor firm performance surrounding an acquisition and compensation rebalancing. Therefore, it appears that CEOs respond to compensation rebalancing by delaying stock option exercise, however rebalancing following an acquisition may depend on more than firm performance. This discovery has implications for both theory and practice. 5.1 Theoretical implications First, the findings of this study contribute to growing recognition that multiple theoretical perspectives are needed to explain compensation management behaviors (Bodolica and Spraggon 2009; Magnan et al. 1998; St-Onge et al. 2001). By using
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the three organizational decision-making perspectives identified by Zajac and Westphal (1997) in developing our logic, this study advances a robust theoretical explanation for how CEOs will respond to efforts by the board of directors to rebalance their annual compensation package following an acquisition. Our findings are particularly noteworthy given that the area of post-acquisition compensation management is relatively unexplored (Bodolica and Spraggon 2009) and yet critical to long-term acquisition success. By using multiple perspectives to explore the rationale for a CEO countermove the present study provides greater insight into the subtle, yet influential, response of CEOs to delay option exercise following boardinduced compensation rebalancing. Second, by using multiple perspectives, this study advances the Behavioral Agency Model (BAM) (Wiseman and Gomez-Mejia 1998) by identifying a context, post-acquisition compensation management where CEOs who have had their compensation rebalanced, in which agency effects outweigh the behavioral effects of the model. The multiple decision-making perspectives illustrate the difficulties of behavioral means available to CEOs seeking to reduce their wealth stake following compensation rebalancing. This study also provides empirical evidence that CEO compensation management is more consistent with the risk-incentives of the agency-based model. This finding reinforces existing work that uses the agency perspective to examine the differences between stock and stock options on the acquisition decision (e.g., Sanders 2001; Sanders and Hambrick 2007) and offers support for subsequent post-acquisition compensation studies to continue to use the agency model for their theoretical development. Third, this study joins other recent work in contributing to the argument that payfor-performance compensation in general, and stock options in particular, may have unintended incentives (Sanders 2001; Sanders and Hambrick 2007). Although stock options are a form of incentive-alignment, intended to offer the CEO personal incentives to pursue strategic decisions that create the most value for shareholders, recent studies have noted that the limitation of personal losses associated with stock options can encourage CEOs to engage in more risky strategic decisions (Sanders 2001; Sanders and Hambrick 2007; Williams and Rao 2006; Wright et al. 2002). This study offers unique evidence that CEOs actively manage their compensation to preserve these acquisitions-encouraging personal risk-incentives. In the light of existing evidence that CEOs very frequently delay exercising their stock options much longer than would be financially expected (Malmendier and Tate 2005, 2008), the phenomenon described here suggests that CEOs actively manipulate their option portfolios to allow them to engage in risky and perhaps self-serving decisions, like acquisitions. Given the incredible increase in stock option-based compensation (Jensen et al. 2004; Murphy 2002), this implication is quite significant, possibly resulting in a systematic and difficult-to-solve governance problem in which the overall prevalence of stock options is driving the continuous increase in the frequency of acquisitions, most of which result in shareholder losses (King et al. 2004). Fourth, this study identifies that CEOs possess a salient indirect defense against board attempts to rebalance their annual compensation packages to include more restricted stock and fewer stock options. Since this reaction is likely motivated by
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Countermove: how CEOs respond to post-acquisition…
the CEO’s desire to pursue more of the very kinds of risky actions that the board is trying to discourage, this discovery opens a number of new questions. Are boards aware the CEOs can counter compensation rebalancing? Why do boards continue to rebalance CEO compensation if CEOs possess a defense? Is compensation rebalancing intended to reassure shareholders rather than discipline managers? If not rebalance compensation, what can boards do to discipline managers for pursuing self-serving acquisitions? These findings open a number of avenues for future research. Fifth, this development also offers another explanation for why CEOs hold onto their options for what would seem to be an irrationally long time period. Prior studies have noted that CEOs often hold on to options either past optimal exercise values or all the way to expiration regardless of value. This failure to exercise stock options is highly correlated with more direct measures of CEO overconfidence, including media portrayal (Malmendier and Tate 2005, 2008). This correlation has been so strong that the failure to exercise stock options is sometimes used alone as a proxy for overconfidence (Doukas and Petmezas 2007). However, this study presents an alternative argument for why CEOs might want to refrain from exercising stock options: CEOs hold onto stock options to preserve risk-incentives when faced with increases in restricted stock grants. As such, this study suggests that a failure to exercise stock options is not necessarily evidence of overconfidence (Roll 1986) or learning effects (Aktas et al. 2009, 2011) and future studies that use option exercise are advised to also control for the CEO’s desire to maintain a relative option-stock balance. Sixth, this study offers evidence that the prevalence of compensation rebalancing is nearly equally common among acquiring firms that performed well and those that performed poorly. This evidence is in contrast to the arguments of Spraggon and Bodolica (2011) which suggest that compensation rebalancing is undertaken as a ‘‘punishment’’ for poor acquisition performance. They observed links between compensation rebalancing and the size of the acquisition premium, the use of stockbased financing, and adjusted stock returns. It should be cautioned that the conditions of this study are not identical to those of Spraggon and Bodolica (2011). Spraggon and Bodolica used a sample of Canadian firms. There may be a national difference in how boards respond to poor acquisitions or which metrics of performance they value. Furthermore, this study does not consider acquisition premiums or stock-based financing. Shareholders may react to these more visible signs of poor managerial judgment more strongly than poor stock market returns. While neither argument is necessary to validate the proposed CEO response studied here, the lack of a relationship between compensation rebalancing and poor firm performance surrounding acquisitions observed herein does raise questions for future research. In particular, are there additional factors, such as moderators, that govern the introduction of post-acquisition compensation restructuring? Seventh, these findings offer another explanation for why firms have been reluctant to offer more stock-heavy compensation packages. It has been commonly recommended that firms adopt more stock-based compensation as a way of ensuring fewer and better performing acquisitions (Datta et al. 2001; Sanders 2001; Sanders and Hambrick 2007). However, if CEOs possess a defense against stock-based
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compensation, as this paper finds, then stock compensation will be less effective. Consequently, this paper cautions the management literature to temper unequivocal calls for the addition of more stock-based compensation. Instead, it recommends that future studies explore how firms could better structure the adoption of additional stock-based compensation to more effectively achieve reductions in firm risk. 5.2 Managerial implications By offering a greater understanding of CEO behavior, this study provides a number of insights of relevance to firms, directors, and shareholders. Most importantly, this study finds evidence that in many instances compensation rebalancing represents a less effective ‘‘punishment’’ than previously believed. While scholars have argued that stock-based compensation should reduce the risk associated with stock options, this study finds that having the board of directors rebalance the CEOs annual compensation to reduce risky acquisitions may not be inherently effective. In the immediate term, CEOs have a useable defense against rebalancing schemes. They can, and do, delay exercising stock options to offset the increase in restricted stock. However, in the long term, this countermove may be less effective. Options have an expiration date and as a consequence can only be delayed for so long before they become worthless. Expiration effectively places a limit on how long a CEO can delay exercising options to counteract compensation rebalancing. As a result, CEOs can initially delay exercising stock options to counterbalance restricted stock grants, but eventually find that their stock options cannot be delayed any longer. This speculation offers the board of directors valuable insight into how to design the CEO’s annual compensation package to better achieve desired effects: reduce stock option exercise windows or increase the time until stock options vest. By shrinking the exercise window, CEOs will have less defense against compensation rebalancing. This solution is particularly notable because it can be adopted prior to knowing whether or not there will ever be a need for compensation rebalancing. Unlike increasing annual restricted stock grants, adopting shorter options exercise windows brings only minor adjustments to hiring compensation packages and can still achieve the intended benefits of option compensation. However, adopting shorter exercise windows also enables compensation rebalancing as an effective ‘‘punishment’’ should the board ever deem it necessary. 5.3 Limitations Of course, all empirical studies of CEO compensation and CEO behavior have their limitations. First, there is significant correlation in many of our control variables. We strongly caution the reader against drawing interpretations regarding the effects of stock returns, stock option values, new stock option grants, and the total level of options held. Correlations between these variables can create difficulties in estimating which variable is the cause of any observed effect. However, there are a number of reasons that multicollinearity should not confound our conclusions. First, correlations between our hypothesis testing variable, compensation rebalancing, and the other control variables remains below 0.03, so multicollinearity
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Countermove: how CEOs respond to post-acquisition…
should not influence our hypothesis testing and conclusions. Second, the major danger of multicollinearity is an increase in the standard errors in a model due to instability in estimated coefficients. If multicollinearity were creating estimation difficulties, we would expect to observe large standard errors in our coefficients or high VIFs, but we do not observe these. Third, if our standard errors were inflated, we would expect a reduction in statistical significance. Yet, we still find statistically significant results. Therefore, while we can remain confident in our hypothesis tests, we do caution readers not to over-interpret our control variables. We are limited in this study in our inability to directly determine CEO intent. The evidence seems to indicate that CEOs whose boards rebalance their compensation act to undo that. It is reasonable to expect that it is because they would like to preserve their ‘‘pre-rebalancing’’ incentive structures. But, we are unable to distinguish between that explanation and other possible reasons CEOs might respond in this way. Another potential area for further study could be to examine what the subsequent behavior (acquisition-related or other) is of these CEOs who respond to rebalancing. In addition, though discussed, we cannot distinguish between CEOs whose behavior may be driven by overconfidence or hubris. Lastly, although we describe this phenomenon in the context of acquisitions, it is possible that the behavior we describe may exist outside of that context. Our arguments stem from the risk-asymmetry of stock options and the personal incentives acquisitions provide. Yet, scholars have identified that stock options also allow CEOs to take other risky decisions like capital expenditures or R&D spending (Sanders and Hambrick 2007). Furthermore, since firm size is a major driver of CEO compensation, CEOs who do not engage in acquisitions still have a strong personal incentive to grow the size of their firm organically (Bliss and Rosen 2001; Tosi et al. 2000). Therefore, it is possible boards may rebalance CEO compensation for non-acquisition reasons, that CEOs have non-acquisition incentives to maintain a risky compensation structure, and that non-acquiring CEOs will also refrain from exercising stock options to maintain their incentives. Nonetheless, acquisitions are a well-studied situation in which significant personal incentives have been identified and is an ideal situation in which to test this behavior. Therefore we caution readers not to interpret our model as applying exclusively to acquisitions and encourage future research to explore other situations in which it may also occur.
6 Conclusion While recent research has identified how boards can respond to poor acquisitions by replacing the CEO’s stock option compensation with restricted stock, this study finds that, in the short-run, chief executives possess an effective defense against this form of compensation rebalancing. Specifically, they can delay exercising stock options to accumulate stock option holdings that counterbalance new restricted stock grants. However, this study also identifies that with some forethought, boards can possess an effective counter defense with only marginal changes to current practices by adopting shorter option exercise windows.
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Appendix See Tables 8, 9, 10, 11, 12, 13 and 14.
Table 8 Variance inflation factors for independent variables Variables
Year of rebalancing
Rebalancing
Year after rebalancing
1.05
1.11
Adjusted stock returns
1.62
1.62
1.35
1.36
Average value of each stock option (log)
2.96
2.96
2.71
2.72
Percent of compensation in form of stock options (log)
3.82
3.82
3.81
3.82
Total number of options held (log)
3.14
3.15
3.13
3.15
New stock options (log)
1.41
1.46
1.41
1.41
Firm size (log of total assets)
1.35
1.35
1.37
1.37
N
3846
3846
3816
3816
Variance inflation factors reported. Values greater than 10 are cause for concern
Table 9 Results of linear regression of percent change in CEO stock option exercise 80 % subsample Variables
Year of rebalancing
Rebalancing Adjusted stock returns Average value of each stock option (log) Percent of compensation in form of stock options (log) Total number of options held (log) New stock options (log) Firm size (log of total assets) Constant N Adjusted R-squared F-statistic of improvement in R-squared F-statistic of overall model fit
0.28*** (0.08) 0.01 (0.04) 0.05 (0.04) -0.08*** (0.03) 0.00 (0.01) 0.02 (0.01) 0.92** (0.38) 3099 0.0210 3.314***
-0.27* (0.15) 0.28*** (0.08) 0.01 (0.04) 0.06 (0.03) -0.08** (0.03) -0.00 (0.01) 0.02 (0.01) 0.89** (0.37) 3099 0.0216 1.854*** 3.494***
Year after rebalancing
-0.14* (0.07) 0.07** (0.04) 0.05 (0.04) -0.08** (0.03) 0.01 (0.01) 0.01 (0.01) 0.89** (0.38) 3074 0.0165 2.889***
-0.09 (0.06) -0.14* (0.07) 0.07* (0.04) 0.06 (0.04) -0.08** (0.03) 0.01 (0.01) 0.01 (0.01) 0.97** (0.39) 3074 0.0168 0.795 2.865***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
123
3099 14,968 0.0277
Non-acquiring firm-year observations
Adjusted R-squared
(0.42)
(0.18)
(0.18)
0.0285
14,968
3099
(0.42)
1.04**
(0.06)
1.08**
-2.09***
-2.09***
(0.01)
(0.06)
(0.01)
0.02
(0.01)
-0.00
(0.03)
-0.08***
(0.03)
0.06*
(0.04)
-0.00
(0.08)
-0.04
(0.01)
(0.01)
0.01
(0.01)
0.05***
(0.01)
-0.01
(0.02)
-0.00
(0.02)
0.33***
(0.03)
0.30***
(0.18)
-2.14***
(0.01)
0.02***
(0.01)
0.05***
(0.01)
-0.02
(0.02)
-0.01
(0.02)
0.27***
(0.03)
0.17***
(0.01)
0.47***
0.0234
14,680
3074
(0.43)
1.01**
(0.06)
-0.03
(0.02)
0.01
(0.01)
0.01
(0.03)
-0.08***
(0.04)
0.06
(0.04)
0.07*
(0.07)
-0.14*
(0.18)
-2.14***
(0.01)
0.02***
(0.01)
0.05***
(0.01)
-0.02
(0.02)
-0.01
(0.02)
0.27***
(0.03)
0.17***
(0.01)
0.47***
0.0239
14,680
3074
(0.43)
1.01**
(0.07)
-0.01
(0.02)
0.01
(0.01)
0.01
(0.03)
-0.08***
(0.04)
0.06
(0.04)
0.07*
(0.07)
-0.14*
(0.06)
-0.05
0.02
(0.01)
(0.01) 0.01
0.00
(0.03)
0.05***
-0.08***
(0.01)
(0.04)
(0.02) -0.01
0.05
(0.04)
(0.02) -0.00
-0.00
0.33***
(0.08)
(0.03)
-0.29***
(0.01) 0.29***
(0.01) -0.29***
0.46***
0.46***
Second stage -0.09
First stage
(0.15)
Second stage
-0.27*
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s Lambda
Firm size (log of total assets)
New stock options (log)
Total number of options held (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 10 Results of Heckman linear regression of percent change in CEO stock option exercise 80 % subsample
Countermove: how CEOs respond to post-acquisition…
123
123 Second stage
(0.483)
(0.472)
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
15.89*** 0.493
0.517
Chi squared for Heckman correction (0.687)
0.163
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
F-statistics of improvement in R-squared
Variables
Table 10 continued
First stage
(0.905)
0.0142
10.11***
Second stage
J. S. Marsh et al.
Countermove: how CEOs respond to post-acquisition… Table 11 Results of probit regression of if CEO exercises stock options 80 % subsample Variables
Year of rebalancing
Rebalancing
Year after rebalancing
-0.15***
-0.15***
(0.04) -0.11*** (0.03)
(0.03)
(0.03)
(0.03)
Average value of each stock option (log)
0.38***
0.38***
0.34***
0.34***
(0.02)
(0.02)
(0.02)
(0.02)
Percent of compensation in form of stock options (log)
-0.00
0.00
0.00
0.00
Total number of options held (log) New stock options (log)
-0.10***
(0.04)
Adjusted stock returns
0.21***
0.22***
(0.01)
(0.01)
(0.02)
(0.02)
0.05***
0.04***
0.03*
0.02
(0.01)
(0.01)
(0.02)
(0.02)
0.03***
0.03***
0.04***
0.04***
(0.01)
(0.01)
(0.01)
(0.01)
Firm size (log of total assets)
0.03***
0.03***
0.04***
0.04***
(0.01)
(0.01)
(0.01)
(0.01)
Constant
-1.81***
-1.74***
-1.64***
-1.57***
(0.17)
(0.17)
(0.19)
(0.19)
N
12,990
12,990
10,349
10,349
McFadden’s adjusted pseudo R-square
0.0907
0.0916
0.0952
0.0962
Chi square likelihood ratio test for improvement in fit
18.03***
17.17***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
123
123 10,457 7610 0.0424
Non-acquiring firm-year observations
McFadden’s adjusted pseudo R-square
(0.19)
(0.15)
(0.15)
0.0423
7610
10,457
(0.19)
-1.45***
(0.03)
-1.45***
-0.49***
-0.49***
(0.01)
(0.03)
(0.01)
0.03***
(0.01)
0.03***
(0.02)
0.02
(0.02)
0.00
(0.02)
0.37***
(0.04)
-0.18***
(0.01)
(0.01)
0.00
(0.01)
0.03***
(0.01)
-0.03***
(0.02)
0.03
(0.02)
0.05***
(0.03)
-0.10***
(0.15)
-0.52***
(0.01)
0.01
(0.01)
0.04***
(0.01)
-0.03***
(0.02)
0.02
(0.02)
0.02
(0.03)
-0.01
(0.03)
1.55***
0.0442
7405
10,349
(0.19)
-1.44***
(0.03)
-0.20***
(0.01)
0.04***
(0.01)
0.03***
(0.02)
0.02
(0.02)
0.00
(0.02)
0.34***
(0.03)
0.22***
(0.15)
-0.52***
(0.01)
0.01
(0.01)
0.04***
(0.01)
-0.03**
(0.02)
0.02
(0.02)
0.02
(0.03)
-0.01
(0.03)
1.56***
0.0444
7405
10,349
(0.19)
-1.42***
(0.03)
-0.17***
(0.01)
0.04***
(0.01)
0.03***
(0.02)
0.02
(0.02)
0.00
(0.02)
0.34***
(0.03)
0.23***
(0.04)
-0.18***
0.03***
(0.01)
(0.01) 0.00
0.03***
(0.02)
0.03***
0.02
(0.01)
(0.02)
(0.02) -0.03***
0.00
(0.02)
(0.02) 0.03
0.37***
0.05***
(0.04)
(0.03)
-0.18***
(0.03) -0.10***
(0.03) -0.18***
1.57***
1.57***
Second stage -0.09**
First stage
(0.08)
Second stage
0.02
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s lambda
Firm size (log of total assets)
New stock options (log)
Total number of options held (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 12 Results of Heckman probit regression of if CEO exercises stock options 80 % subsample
J. S. Marsh et al.
Second stage
(0.00)
(0.00)
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
0.0335 29.82***
29.75***
Chi squared for Heckman correction (0.00)
25.51***
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Chi square likelihood ratio test for improvement in fit
Variables
Table 12 continued
First stage
(0.00)
25.51***
6.252***
Second stage
Countermove: how CEOs respond to post-acquisition…
123
J. S. Marsh et al. Table 13 Results of linear regression of percent change in CEO stock option holdings 80 % subsample Variables
Year of rebalancing
Rebalancing
Year After rebalancing
0.38***
0.23***
(0.08) 0.15*** (0.04)
(0.04)
(0.04)
(0.04)
Average value of each stock option (log)
-0.08***
-0.08***
-0.08***
-0.07***
(0.02)
(0.02)
(0.02)
(0.02)
Percent of compensation in form of stock options (log)
-0.01
-0.01
-0.01
-0.01
New stock options (log) Percent change in stock option grants (log)
0.15***
(0.05)
Adjusted stock returns
0.08**
0.07*
(0.02)
(0.02)
(0.02)
(0.02)
0.00
0.00
0.01
0.01
(0.01)
(0.01)
(0.01)
(0.01)
0.13***
0.14***
0.12***
0.12***
(0.01)
(0.01)
(0.01)
(0.01)
0.00
0.00
-0.00
-0.00
(0.01)
(0.01)
(0.01)
(0.01)
0.72***
0.71***
0.77***
0.67***
(0.13)
(0.13)
(0.14)
(0.14)
N
11,670
11,670
10,349
10,349
Adjusted R-squared
0.0529
0.0542
0.0507
0.0537
Firm size (log of total assets) Constant
F-statistic of improvement in R-squared F-statistic of overall model fit
15.35*** 10.85***
10.55***
33.27*** 9.760***
9.833***
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares Controls for interpolated values and year dummies are included but not shown to conserve space *** p \ 0.01; ** p \ 0.05; * p \ 0.1
123
10,456 7611 0.0533
Non-acquiring firm-year observations
Adjusted R-squared
(0.11)
(0.17)
(0.17)
0.0547
7611
10,456
(0.11)
0.23**
(0.03)
0.24**
-0.71***
-0.72***
(0.01)
(0.03)
(0.01)
0.01
(0.01)
0.14***
(0.01)
0.00
(0.02)
-0.00
(0.02)
-0.08***
(0.04)
0.12***
(0.01)
(0.01)
0.00
(0.01)
0.03***
(0.01)
-0.02
(0.02)
0.02
(0.02)
0.05***
(0.03)
0.15***
(0.17)
-0.75***
(0.01)
0.01
(0.01)
0.03***
(0.01)
-0.02
(0.02)
0.02
(0.02)
0.03*
(0.03)
0.01
(0.03)
1.58***
0.0515
7405
10,349
(0.11)
0.25**
(0.04)
0.11***
(0.01)
0.00
(0.01)
0.12***
(0.01)
0.01
(0.02)
-0.00
(0.02)
-0.08***
(0.04)
0.07*
(0.17)
-0.74***
(0.01)
0.01
(0.01)
0.03***
(0.01)
-0.02*
(0.02)
0.02
(0.02)
0.03*
(0.03)
0.01
(0.03)
1.58***
0.0547
7405
10,349
(0.10)
0.26***
(0.02)
0.06**
(0.01)
0.00
(0.01)
0.12***
(0.01)
0.01
(0.02)
-0.01
(0.02)
-0.07***
(0.04)
0.06*
(0.05)
0.12***
0.01
(0.01)
(0.01) 0.00
0.13***
(0.01)
0.03***
0.00
(0.01)
(0.02)
(0.02) -0.02
-0.00
(0.02)
(0.02) 0.02
-0.08***
0.05***
(0.04)
(0.03)
-0.15***
(0.03) 0.15***
(0.03) -0.15***
1.59***
1.59***
Second stage 0.20***
First stage
(0.09)
Second stage
0.38***
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
Acquiring firm-year observations
Constant
Heckman’s Lambda
Firm size (log of total assets)
Percent change in stock option grants (log)
New stock options (log)
Percent of compensation in form of stock options (log)
Average value of each stock option (log)
Adjusted stock returns
Number of prior completed acquisitions (log)
Rebalancing
Variables
Table 14 Results of Heckman linear regression of percent change in CEO stock option holdings 80 % subsample
Countermove: how CEOs respond to post-acquisition…
123
123 Second stage
(0.00)
(0.00)
*** p \ 0.01; ** p \ 0.05; * p \ 0.1
Controls for interpolated values and year dummies are included but not shown to conserve space
Standard errors for coefficients in parentheses; p values in parentheses for Chi squares
25.48*** 13.35***
12.83***
Chi squared for Heckman correction (0.005)
7.821***
Second stage
First stage
First stage
First stage
Second stage
Year after rebalancing
Year of rebalancing
F-statistic of improvement in R-squared
Variables
Table 14 continued
First stage
(0.02)
4.953**
59.67***
Second stage
J. S. Marsh et al.
Countermove: how CEOs respond to post-acquisition…
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