Undermining incentives: CEO reactions to compensation rebalancing
- PDF / 493,311 Bytes
- 27 Pages / 439.37 x 666.142 pts Page_size
- 33 Downloads / 200 Views
Undermining incentives: CEO reactions to compensation rebalancing John S. Marsh1
•
Rachel Graefe-Anderson1
Springer Science+Business Media, LLC 2017
Abstract Directors commonly ‘‘punish’’ CEOs for overly risky behavior by rebalancing their compensation to include more restricted stock and fewer stock options. This paper extends the behavioral-agency model to describe how CEOs will manage their holdings of stock and stock options in response to this form of compensation rebalancing. In doing so, it finds that CEOs respond by selling existing stock holdings and accumulating option holdings. This behavior achieves the opposite incentive structure that such rebalancing intends to create, raising questions about the effectiveness of compensation rebalancing in reducing risky decision making. Keywords Behavioral agency theory Stock options Executive compensation Corporate governance Risk-taking
1 Introduction Recent scholarly work has identified that boards of directors react to the performance of the CEO by continually making adjustments to the CEO’s compensation package to adjust the CEO’s incentives. Specifically, directors frequently ‘‘punish’’ CEOs that take excessive risks by ‘‘rebalancing’’ the CEOs annual pay package to include fewer grants of risk-encouraging stock options and larger grants of risk-discouraging restricted stock (Spraggon and Bodolica 2011). & John S. Marsh [email protected] Rachel Graefe-Anderson [email protected] 1
College of Business, University of Mary Washington, 1301 College Avenue, Fredericksburg, VA 22401, USA
123
J. S. Marsh, R. Graefe-Anderson
This risk-dissuading swap of stock-options for restricted stock in the CEO’s annual pay package is commonly referred to as ‘‘compensation rebalancing’’.1 Although this kind of compensation rebalancing has become popular in practice, recent examples suggest it has not assuaged investors. This paper attempts to describe why. In 2014, Coca-Cola’s investors were becoming increasingly concerned about the company’s poor performance and recent series of aggressive and expensive acquisitions. The directors of Coca-Cola assured investors that this would no longer be a problem because they had adjusted CEO Muhtar Kent’s compensation package to include more restricted stock and fewer stock options (Chakrabarty and Sharma 2014). The scholarly literature would have argued that this type of compensation rebalancing would have led to less risky strategic decisions. This expectation derives from the behavioral agency model (BAM) which attributes differing risk incentives to individual components of equity-based pay (Devers et al. 2008; Martin et al. 2013; Alessandri and Pattit 2014). Stock option grants represent potential future wealth gains and encourage CEOs to take risks while restricted stock grants represent current wealth at-stake and discourage CEOs from taking risks. Yet in April 2015, Coca-Cola announced it would acquire a Chinese protein-drink maker for $400 million (Rochen 2015). This anecdote suggests that this swapping of annual stoc
Data Loading...
