Are Stock Options the Managers' Blessing? Stock Option Compensation and Institutional Controls

Abstract

Stock option grants to top managers have largely contributed to the dramatic increase in US executive pay in recent years. In this paper it is argued that stock options, compared to other forms of compensation, have created strong incentives for managers to engage in lobbying activities for higher compensation. The empirical results presented for the S&P 500 firms and the years from 1992 to 1997 show that the relative success of such skimming activities is shaped by institutional controls. Stock option grants are substantially lower when control by the board of directors and the shareholders is higher, and competition on the product market of a firm is stronger. (108 words) JEL classification: G3, J3, L2, M1

CEO power and the structure of CEO pay

“…The interpretation by Cyert et al is that the CEO's equity-based compensation is seen as the sign of CEO power: more powerful CEOs enjoy the profligacy of awarding themselves more equity-based compensation since the dilution effect outweighs incentive effects. Benz, Kucher, and Stutzer (2001) report similar findings in relation to stock option awards to top executives. This is largely consistent with Bebchuk and Grinstein (2005), who show that total compensation for CEOs in large US firms has risen considerably during the period of 1993-2003, with much of the increase due to an increase in equity-based compensation, without a reduction in cash compensation.…”

Discussion—Stock Option Compensation and Earnings Management Incentives

“…Blanchard, Lopez-de-Silva, and Shleifer (1 994) argue that failings of corporate governance systems often allow managers to "grab whatever profits they can get away with." Benz, Kucher, and Stutzer (2001) argue that stock options have created strong incentives for managers to engage in lobbying activities for higher compensation. However, the relative success of this behavior is shaped by institutional controls.…”

Common Ownership and Executive Incentives: The Implausibility of Compensation As an Anticompetitive Mechanism

“…155 Whatever the reason, the empirical evidence suggests that equity compensation grants are not fully offset by reductions in base pay. 156 So while companies could adjust the sensitivity of current compensation to company performance year by year by shifting compensation dollars between salary and equity-based pay, there is no evidence that they do so. Of course, companies can and do adjust WPS when they increase or decrease equity pay grants, but obviously this affects an executive's total compensation as well as WPS.…”