Good Timing: CEO Stock Option Awards and Company News Announcements
David Yermack
JF June 1997
Executive Summary:
CEOs are granted "shortly before favorable corporate news." However, the author rejects "insider trading and manipulation of new announcement dates. A view that is consistent with the findings is the CEOs influence the makeup of their pay. When the CEO expects good times, he influences the compensation committee to pay more with options.
The paper begins with the implicit assumption that the evidence on pay for performance is correct (Larcker 1983, DeFusco, Johnson, and Zorn 1990) and that there is a link. This link however is "consistent with two interpretations. Incentive compensation might motivate managers to make superior decisions. Alternatively, managers might have influence over the terms of their own compensation and use this power to obtain more performance-based pay in advance of anticipated stock price increases."
Due to increased reporting requirements, additional data is available to investigate whether firms do "time" their stock option grants. This paper looks at option grants at Fortune 500 firms between 1992-1994.
Yermack cites evidence from proxies that management does have influence over their own compensation. For example the 1994 Intel proxy reports that "'stock options for the executive orders were granted upon recommendation of management."
Most option grants are not announced until well after (up to 15 months after) the actual grant date. This allows an event study to be performed that is free of signaling effects. The main result of this study is that in the 10 weeks following option grants, the firm's stock "outperforms the market on a risk-adjusted basis by slightly more than 2 percent." This 2% abnormal return remains embedded in the future price which does not appear to revert after the 50 day period.
However, Yermack does not find evidence of a pre-grant downward drift that would be consistent with holding up the option grant until all bad news had been released.
Interestingly, Yermack also tries to separate offerings into those that are predictable (that is occur at the same time frame (with a month) for at least two consecutive years from those that are less predictable. Although the test is admittedly weak, those firms with unpredictable grant dates awarded the options "at more favorable times." (This is significant at the 11% level.)
Further evidence that at least some CEOs influence the option grant process is found by looking at the returns surrounding Option Grants to CEOs who:
- are on the compensation committee
- who have an nonexecutive Chairman of the board on the compensation committee
- if a outside holder of 5% (or more) sits on the Compensation committee
- whether all compensation committee members were appointed by previous CEOs.
All of these investigations point to the idea that CEOs, if able, influence the grant dates. For example table II reports that for the 13 CEOs who are also on the compensation committee the "average 50-day CAR following the awards is a startlingly high 11.2%, well above the sample average of 2.2%"
Table III similarly reports that the difference between returns when the CEO has more influence and when his influence is constrained is constantly significant.
Cumulative Abnormal Stock Returns After CEO Stock Option Awards as a function of Compensation Committee Membership |
|||
| Sample Size | Mean 50-Day CAR% | T-stat | |
| Nonexecutive chairman serves on compensation committee All others Difference |
13 301
|
-1.09 3.1 -4.19 |
-.72 4.09 -2.48 |
| Outside 5 percent Stockholder director serves on committee All others Difference |
19 295 |
0.61 3.07 -2.46 |
.056 3.84 -1.82 |
| All Committee members appointed by previous CEOs All others Difference |
71 243 |
1.86 3.23 -1.37 |
1.24 3.72 -0.79 |
The author also looks at earnings announcements (both good and bad) but find no evidence that managers rush bad earnings to market around this period. In fact is anything, the evidence is consistent with Kross and Schroeder (1984), Penman (1984), and Kalay and Lowenstein (1986) that firms push good news to the market faster than bad news.
The conclusion to this is that CEOs may influence a switch towards a higher amount of performance based pay when they believe the future to be bright for the firm.
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