Managerial incentives and stock price dynamics: an experimental approach
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Managerial incentives and stock price dynamics: an experimental approach Te Bao1 · Edward Halim1 · Charles N. Noussair2 · Yohanes E. Riyanto1 Received: 25 January 2020 / Revised: 21 August 2020 / Accepted: 28 August 2020 © Economic Science Association 2020
Abstract We investigate experimentally how granting a manager stock ownership and the opportunity to trade shares of a company’s stock influence the manager’s effort and the overall behavior of the market for the company’s shares. In our design, managerial effort affects the fundamental value of the firm. Our findings suggest that endowing a manager with stock does not significantly increase the manager’s effort. When the manager is allowed to trade the company’s shares, however, she tends to accumulate additional shares, increase her effort, and raise company value. In all of our treatments, prices tend to reflect underlying fundamentals, and bubbles are rare. Keywords Stock-based compensation · Managerial incentives · Experimental finance · Asset bubbles · Agency problem JEL Classification C91 · C92 · D53 · D86 · M1
1 Introduction The economic analysis of managerial compensation has been a long-standing topic in corporate finance, as the world has witnessed a sharp increase in executive remuneration since the 1980s. According to the Economic Policy Institute (Mishel and Schieder 2018), the average ratio between the compensation of top executives and the median employee in the same company has increased from roughly 20 in the Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1068 3-020-09675-7) contains supplementary material, which is available to authorized users. * Charles N. Noussair [email protected] 1
Division of Economics, School of Social Sciences, Nanyang Technological University, Singapore, Singapore
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Department of Economics, Eller College of Management, The University of Arizona, Tucson, USA
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1960s to about 312 in 2017. The increase has stimulated much discussion among researchers and the general public regarding whether such high payments to executives are justified. The world has also witnessed a change in the structure of executive and employee compensation. According to Frydman and Saks (2010), managerial compensation was primarily composed of salaries and bonuses until the 1950s. Starting in the 1960s, firms began to partially pay CEOs with long term incentives in cash or shares of stock. In the 1970s, stock options were introduced, and they became the largest component of top executive pay by the 2000s, before they were replaced by restricted stocks after the market decline of 2008. See Frydman and Jenter (2010) for an overview of work in CEO compensation. Theoretically, stock-based incentives are an appropriate response to the agency problem between managers and shareholders (Jensen and Meckling 1976; Jensen and Murphy 1990). Granting stock ownership aligns the managers’ incentives with those of the shareholders. Indeed, Mehran
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