This book provides a detailed account of how structural flaws in corporate governance have enabled managers to influence their own pay and produced widespread distortions in pay arrangements. The book also examines how these flaws and distortions can best be addressed. Part I of the book (titled The Official View and its Limits) critically examines the arm's length contracting view, which underlies much of the academic research on executive compensation as well as the law's approach to it. We show that boards have not been operating at arm's length from the executives whose pay they set. While recent reforms can improve matters, they cannot be expected to eliminate significant deviations from arm's length contracting. We also show that the constraints imposed by market forces and shareholders' power to intervene are not tight enough to prevent such deviations. Part II of the book (titled Power and Pay) shows how an understanding of the role of managerial power can help explain executive compensation practices. We provide a framework for assessing whether pay arrangements are a product of managerial influence. We discuss managers' interest in camouflaging the amount and the performance-insensitivity of their pay. Applying our framework, we discuss how managerial influence can help explain, among other things, the evidence on the relationship between managerial pay and managerial power; the use of retirement benefits and other compensation arrangements to provide stealth compensation; and the ability of departing managers to obtain more than their contractual entitlement. Part III of the book (titled Decoupling Pay from Performance) examines how managerial influence has operated to reduce the performance-sensitivity of executive pay. Among other things, we examine the structure of non-equity compensation, the design of conventional option plans, the use of restricted stock grants, and managers' freedom to unload options and shares. Part IV of the book (titled Going Forward) discusses how executive compensation - and corporate governance more generally - can be improved. We examine the extent to which pay arrangements can be improved by adopting board process rules, imposing shareholder approval requirements, and making pay more transparent. We conclude that problems with compensation arrangements cannot be fully addressed without ensuring that directors focus on shareholder interests and operate at arm's length from the executives whose compensation they set. To achieve this result, we argue, it is not sufficient to make directors independent of executives as recent reforms has sought to do; it is also necessary to make directors dependent on shareholders by changing the legal arrangements that insulate boards from shareholders.

/pdf/pay-without-performance-the-unfulfilled-promise-of-executive-2jxhdecmc3.pdf

Pay without Performance: The Unfulfilled Promise of Executive Compensation

This paper contains a draft of Part III of our forthcoming book, Pay without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press, September 2004). The book provides a detailed account of how structural flaws in corporate governance have enabled managers to influence their own pay and produced widespread distortions in pay arrangements. The book also examines how these flaws and distortions can best be addressed. Part III of the book examines how managerial influence has operated to reduce the performance-sensitivity of executive pay. Among other things, we examine the structure of non-equity compensation, the design of conventional option plans, the use of restricted stock grants, and managers’ freedom to unload options and shares.

/pdf/pay-without-performance-the-unfulfilled-promise-of-executive-2s8l63codl.pdf

Pay without Performance, The Unfulfilled Promise of Executive Compensation, Part III: The Decoupling of Pay from Performance

I develop a corporate governance framework, provide a broad overview of recent corporate governance research, and place each of the Special Issue papers within the context of this framework The papers in the issue contribute to our understanding of a wide range of governance topics including: the role of antitakeover measures, board structure, capital market governance, compensation and incentives, debt and agency costs, director and officer labor markets, fraud, lawsuits, ownership structure, and regulation In short, the papers span almost every aspect of governance systems

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID900625_code221791.pdf?abstractid=855444&mirid=1

Recent Developments in Corporate Governance: An Overview

A central tenet of agency theory is that there is potential for mischief when the interests of owners and managers diverge. In those circumstances, and for a variety of reasons, managers may be able to exact higher rents than are reasonable or than the owners of the firm would otherwise accord them. While that foundational element of agency theory is secure, other elements derived directly from agency theory are far less settled. Indeed, even after some 75 years of conceptualization and empirical research, the three principal approaches that have long been proposed to mitigate the fundamental agency problem remain contentious. Accordingly, we provide a review of the fundamental agency problem and its mitigation through independence, equity, and the market for corporate control.

1 The Fundamental Agency Problem and Its Mitigation: Independence, Equity, and the Market for Corporate Control

This study documents that the abnormal stock returns are negative before unscheduled executive option awards and positive afterward. The return pattern has intensified over time, suggesting that executives have gradually become more effective at timing awards to their advantage, and possibly explaining why the results in this study differ from those in past studies. Moreover, I document that the predicted returns are abnormally low before the awards and abnormally high afterward. Unless executives possess an extraordinary ability to forecast the future marketwide movements that drive these predicted returns, the results suggest that at least some of the awards are timed retroactively.

https://www.biz.uiowa.edu/faculty/elie/Grants-MS.pdf

On the Timing of CEO Stock Option Awards

We investigate whether executive stock option repricings are systematically timed to coincide with favorable movements in the company's stock price. For a sample of 236 repricing events, we observe sharp increases in stock price in the 20-day period following the repricing date. In addition, repricing dates tend to either precede the release of good news or follow the release of bad news in the quarterly earnings announcements. Since information about stock option repricing is not generally released to the public around the repricing date, these findings suggest that CEOs opportunistically manage the timing of the option repricing date.

/pdf/the-timing-of-option-repricing-1b1vsbqexj.pdf

The Timing of Option Repricing

For options with a reload feature, the holder is automatically entitled to new options when the initial option is exercised. Under Statement of Financial Accounting Standards No. 123, the grant date value of executive stock options excludes the value of a reload feature because the Financial Accounting Standards Board believes it is not feasible to value a reload feature at the grant date. We show how the Binomial Option Pricing Model can be used to value options and the reload feature at the grant date. Ignoring the reload can substantially understate the value of the option. Accordingly, the Financial Accounting Standards Board may wish to reconsider the accounting for reload features.

/pdf/valuing-the-reload-features-of-executive-stock-options-3art9d00sc.pdf

Valuing the Reload Features of Executive Stock Options

This paper investigates whether firms time the stock option repricing to coincide with favorable movements in the company's stock price. For a sample of 166 firms that repriced executive stock options during the period 1992 through 1997, we show that, in general, stock price rises sharply on the repricing date and continues to increase for the next twenty days. In addition, repricing often occurs just following the release of bad news or just prior to good news. Since no information about the stock option repricing is released around the repricing date, the evidence above is suggestive of management timing the option repricing date to precede other good news events that are announced.

Under Statement of Financial Accounting Standards No. 123, the grant date value of executive stock options excludes the value of any reload feature because, at the time of writing the standard in 1995, the Financial Accounting Standards Board believed it was not feasible to value a reload feature at the grant date. We show how the Binomial Option Pricing Model can be used to determine the grant date value of such options. Ignoring the reload feature can substantially understate the value of the option: the reload feature increases the value of an otherwise similar option by 24 percent in the example we consider. In view of the potential significance of the reload feature and the versatility of the Binomial Option Pricing Model, the Financial Accounting Standards Board may wish to reconsider the accounting for options with a reload feature.

https://papers.ssrn.com/sol3/Delivery.cfm/nber_w7020.pdf?abstractid=155559

Statement of Financial Accounting Standards No. 123 recommends that reload options be valued at the time the reload feature is activated and not at the time of the initial grant. We demonstrate that ignoring the reload feature at the time of the initial grant can substantially understate the value of the option granted. In the example we consider the reload feature increases the value of an otherwise similar option by 31 percent. We show how the Binomial Option Pricing Model can be used to value options with a reload feature at the time of the initial grant. In view of the potential significance of the reload feature and the versatility of the Binomial Option Pricing Model, the Financial Accounting Standards Board may wish to reconsider its recommendation regarding the valuation of the reload feature.

P. Jane Saly

Papers

The Timing of Option Repricing

Valuing the Reload Features of Executive Stock Options

The Timing of Option Repricing

Valuing the Reload Features of Executive Stock Options

Ignoring Reload Features Can Substantially Understate the Value of Executive Stock Options