1 Introduction
2 Executive stock options and FAS 123R
3 Related research and theory
3.1 Option pay and opportunistic management behavior
4 Empirical methodology
4.1 Identification strategy
4.2 Data and sample
Firm-years | |
---|---|
Intersection of Compustat/CRSP/I/B/E/S/Execucomp, 2002–2007 | 8,145 |
Less: | |
Financial institutions and utility sector firms | −2,137 |
Missing variables | −1,455 |
Firms without observations in both the pre- and post-event periods | −383 |
Fewer than five analysts following the firm | −914 |
Final sample | 3,256 |
4.3 Beating analysts’ forecasts
5 Results
5.1 Changes in CEO compensation and incentives around FAS 123R
Panel A: Full sample (firm-years = 3,256) (distinct firms = 757) | |||||
Variable | Mean | Standard Deviation | Q1 | Median | Q3 |
Total compensation | 5.630 | 4.978 | 2.027 | 4.050 | 7.510 |
Delta | 58.924 | 75.467 | 6.937 | 31.366 | 79.936 |
Vega | 14.629 | 26.952 | 0.000 | 1.976 | 16.706 |
Option pay ratio | 0.356 | 0.286 | 0.000 | 0.351 | 0.593 |
Salary ratio | 0.253 | 0.215 | 0.114 | 0.184 | 0.305 |
Bonus ratio | 0.196 | 0.161 | 0.080 | 0.168 | 0.274 |
Restricted stock ratio | 0.125 | 0.179 | 0.000 | 0.000 | 0.232 |
LTIA ratio | 0.067 | 0.148 | 0.000 | 0.000 | 0.000 |
Market value | 9,097.376 | 19,242.382 | 1,112.051 | 2,695.999 | 7,977.014 |
Leverage | 0.161 | 0.146 | 0.009 | 0.147 | 0.256 |
Return on assets | 0.111 | 0.089 | 0.068 | 0.108 | 0.158 |
Book to market | 0.400 | 0.262 | 0.234 | 0.343 | 0.516 |
Cash | 0.173 | 0.175 | 0.037 | 0.107 | 0.258 |
Dividends | 0.517 | 0.500 | 0.000 | 1.000 | 1.000 |
Investment growth | 0.186 | 0.557 | −0.119 | 0.103 | 0.358 |
Shares | 232.630 | 416.465 | 42.272 | 88.645 | 218.576 |
Altman-Z | 5.464 | 4.853 | 2.727 | 4.075 | 6.374 |
CEO tenure | 6.790 | 6.649 | 2.000 | 5.000 | 9.000 |
Number estimate | 12.578 | 6.508 | 7.000 | 11.000 | 16.000 |
Panel B: Full sample pre- and post-FAS 123R | |||||
Pre-FAS 123R (2002–2004) | Post-FAS 123R (2005–2007) | ||||
Variable | Mean | Median | Mean | Median | |
Total compensation | 5.347 | 3.741 | 5.885 | 4.219 | |
Delta | 59.289 | 33.485 | 58.595 | 28.109 | |
Vega | 19.251 | 5.463 | 10.472 | 0.054 | |
Option pay ratio | 0.436 | 0.465 | 0.284 | 0.260 | |
Salary ratio | 0.262 | 0.189 | 0.245 | 0.182 | |
Bonus ratio | 0.185 | 0.161 | 0.206 | 0.177 | |
Restricted stock ratio | 0.075 | 0.000 | 0.171 | 0.116 | |
LTIA ratio | 0.041 | 0.000 | 0.091 | 0.000 | |
Market value | 8,350.234 | 2,291.846 | 9,769.542 | 2,994.945 | |
Leverage | 0.168 | 0.159 | 0.155 | 0.138 | |
Return on assets | 0.102 | 0.102 | 0.119 | 0.113 | |
Book to market | 0.410 | 0.349 | 0.390 | 0.336 | |
Cash | 0.178 | 0.112 | 0.168 | 0.105 | |
Dividends | 0.494 | 0.000 | 0.538 | 1.000 | |
Investment growth | 0.139 | 0.041 | 0.228 | 0.147 | |
Shares | 231.183 | 85.610 | 233.932 | 91.085 | |
Altman-Z | 5.593 | 4.001 | 5.348 | 4.140 | |
CEO tenure | 6.754 | 5.000 | 6.822 | 5.000 | |
Number estimate | 12.645 | 11.000 | 12.518 | 11.000 | |
Observations | 1,542 | 1,542 | 1,714 | 1,714 | |
Panel C: Treatment and control groups | |||||
Treatment group (unique firms = 687) | Control group (unique firms = 70) | ||||
Variable | Mean | Median | Mean | Median | |
Total compensation | 5.643 | 4.071 | 5.505 | 3.618 | |
Delta | 59.597 | 32.465 | 52.530 | 18.094 | |
Vega | 15.022 | 2.485 | 10.896 | 0.000 | |
Option pay ratio | 0.375 | 0.373 | 0.178 | 0.000 | |
Salary ratio | 0.242 | 0.182 | 0.359 | 0.234 | |
Bonus ratio | 0.192 | 0.165 | 0.231 | 0.204 | |
Restricted stock ratio | 0.124 | 0.000 | 0.140 | 0.000 | |
LTIA ratio | 0.065 | 0.000 | 0.089 | 0.000 | |
Market value | 8,269.102 | 2,702.872 | 16,968.644 | 2,677.064 | |
Leverage | 0.161 | 0.145 | 0.163 | 0.155 | |
Return on assets | 0.110 | 0.108 | 0.122 | 0.111 | |
Book to market | 0.396 | 0.341 | 0.430 | 0.366 | |
Cash | 0.176 | 0.111 | 0.142 | 0.084 | |
Dividends | 0.494 | 0.000 | 0.735 | 1.000 | |
Investment growth | 0.186 | 0.101 | 0.184 | 0.113 | |
Shares | 219.327 | 88.156 | 359.047 | 90.451 | |
Altman-Z | 5.436 | 4.088 | 5.729 | 3.901 | |
CEO tenure | 6.553 | 5.000 | 9.042 | 5.000 | |
Number estimate | 12.628 | 11.000 | 12.106 | 10.000 | |
Observations | 2,946 | 2,946 | 310 | 310 |
Panel A: Change in option pay for all groups | ||||||
Pre-FAS 123R (2002–2004) | Post-FAS 123R (2005–2007) | Difference | ||||
Treatment group | 0.469 | 0.291 | −0.178*** | |||
Control group 1 | 0.000 | 0.130 | 0.130*** | |||
Control group 2 | 0.325 | 0.281 | −0.044 | |||
Panel B: Option pay ratio difference-in-differences regression | ||||||
\( Option\ pay\ ratio={\beta}_1 Post+{\beta}_2 Treat+{\beta}_3 Post\ast Treat+{\sum}_{k=1}^K{\beta}_{3+k}{Controls}_k+\varepsilon \) | ||||||
Variable | Column 1: Option pay - industry fixed effects | Column 2: Option pay - firm and year fixed effects | Column 3: Delta - industry fixed effects | Column 4: Delta - firm and year fixed effects | Column 5: Vega - industry fixed effects | Column 6: Vega - firm and year fixed effects |
Post | 0.055* | 21.125** | 0.945 | |||
(1.864) | (2.510) | (0.364) | ||||
Treat | 0.282*** | 35.887*** | 12.057*** | |||
(8.760) | (4.758) | (5.203) | ||||
Post ∗ Treat | −0.226*** | −0.201*** | −32.244*** | −27.171*** | −12.025*** | −11.380*** |
(−7.275) | (−6.609) | (−3.744) | (−3.008) | (−4.341) | (−3.869) | |
log(Market value) | 0.034*** | 0.046*** | 30.126*** | 32.550*** | 6.010*** | −0.452 |
(6.344) | (2.665) | (17.067) | (8.518) | (12.581) | (−0.275) | |
Leverage | 0.003 | 0.005 | 1.862 | 0.232 | −1.137 | 0.403 |
(0.395) | (0.698) | (1.025) | (0.123) | (−1.456) | (0.531) | |
Return on assets | 0.009 | −0.022 | 9.432 | −12.736 | −0.687 | −5.127 |
(0.185) | (−0.335) | (0.759) | (−0.806) | (−0.179) | (−0.781) | |
Investment growth | −0.310*** | −0.180 | −20.362 | −33.378 | −11.848* | 25.310** |
(−3.529) | (−1.460) | (−0.955) | (−1.294) | (−1.773) | (2.146) | |
Altman − Z | 0.008*** | 0.002 | 0.541 | 1.406* | −0.016 | −0.343 |
(4.098) | (0.853) | (1.005) | (1.872) | (−0.084) | (−1.171) | |
Cash | 0.098** | −0.045 | −12.391 | 18.737 | 5.944 | −3.227 |
(2.027) | (−0.626) | (−1.070) | (1.124) | (1.588) | (−0.505) | |
Dividends | −0.071*** | 0.017 | −5.103 | −5.660 | −0.005 | 0.962 |
(−4.833) | (0.633) | (−1.527) | (−1.150) | (−0.005) | (0.418) | |
CEO tenure | −0.003*** | −0.007*** | −0.081 | −0.054 | −0.094 | −0.374*** |
(−2.697) | (−3.974) | (−0.336) | (−0.160) | (−1.358) | (−2.639) | |
Industry fixed effects | Yes | – | Yes | – | Yes | – |
Firm and year fixed effects | – | Yes | – | Yes | – | Yes |
Observations | 3,256 | 3,256 | 3,256 | 3,256 | 3,256 | 3,256 |
Adj. R2 | 0.239 | 0.597 | 0.358 | 0.626 | 0.154 | 0.412 |
Panel C: Other compensation changes | ||||||
Variable | Column 1: Log (Total compensation) | Column 2: Salary ratio | Column 3: Bonus ratio | Column 4: Restricted stock ratio | Column 5: LTIA ratio | |
Post | 0.286*** | −0.097*** | −0.075*** | 0.072*** | 0.043* | |
(3.790) | (−3.809) | (−3.984) | (3.905) | (1.958) | ||
Treat | 0.564*** | −0.183*** | −0.074*** | −0.016 | −0.009 | |
(4.783) | (−5.957) | (−3.918) | (−0.812) | (−0.575) | ||
Post * Treat | −0.301*** | 0.107*** | 0.096*** | 0.023 | 0.002 | |
(−3.829) | (4.052) | (4.898) | (1.165) | (0.107) | ||
Control variables | Yes | Yes | Yes | Yes | Yes | |
Industry fixed effects | Yes | Yes | Yes | Yes | Yes | |
Observations | 3,256 | 3,256 | 3,256 | 3,256 | 3,256 | |
Adj. R2 | 0.468 | 0.240 | 0.107 | 0.148 | 0.139 |
5.2 Effect of option pay on beating analysts’ targets.
\( Prob\left( Meet\ or\ beat\right)={\beta}_1 Post+{\beta}_2 Treat+{\beta}_3 Post\ast Treat+{\sum}_{k=1}^K{\beta}_{3+k}{Controls}_k+\varepsilon \) | ||||||||
---|---|---|---|---|---|---|---|---|
Column 1: Logit no controls | Column 2: Logit with controls | Column 3: Logit firm and year FE | Column 4: OLS firm and year FE | Column 5: OLS Cross-section high impact | ||||
Variable | Coeff. (Z-stat.) | Marginal effects | Coeff. (Z-stat.) | Marginal effects | Coeff. (Z-stat.) | Marginal effects | Coeff. (t-stat.) | Coeff. (t-stat.) |
Post | 0.153 | 0.032 | 0.187 | 0.040 | ||||
(0.559) | (0.676) | |||||||
Treat | 0.723*** | 0.154*** | 0.739*** | 0.157*** | ||||
(3.523) | (3.536) | |||||||
Post * Treat | −0.654** | −0.139** | −0.670** | −0.142** | −0.827** | −0.198** | −0.109** | −0.051 |
(−2.285) | (−2.324) | (−2.186) | (−2.459) | (−1.037) | ||||
Post * Treat * | −0.274*** | |||||||
High impact | (−3.001) | |||||||
Post * High impact | 0.228*** | |||||||
(2.816) | ||||||||
log(Market value) | −0.108** | −0.024** | 0.301 | 0.068 | 0.036 | 0.042 | ||
(−2.126) | (1.225) | (1.008) | (1.168) | |||||
Book to market | −0.508*** | −0.107*** | 0.279 | 0.061 | 0.027 | 0.035 | ||
(−2.746) | (0.557) | (0.369) | (0.486) | |||||
Sales growth | −0.434** | −0.092** | −0.493 | −0.124 | −0.065 | −0.069 | ||
(−2.040) | (−1.300) | (−1.464) | (−1.549) | |||||
Net operating | −0.020 | −0.004 | −0.068 | −0.015 | 0.002 | 0.004 | ||
assets | (−0.470) | (−0.405) | (0.375) | (0.574) | ||||
Shares | 0.000 | 0.000* | 0.000 | 0.000 | 0.000 | 0.000 | ||
(1.636) | (0.179) | (0.038) | (0.051) | |||||
Implicit claim | 0.295* | 0.063* | 0.272 | 0.086 | 0.040 | 0.045 | ||
(1.693) | (0.315) | (0.321) | (0.361) | |||||
Number estimate | 0.029*** | 0.006*** | 0.031 | 0.008 | 0.005 | 0.005 | ||
(3.505) | (1.463) | (1.485) | (1.462) | |||||
CV estimate | 0.211 | 0.044 | 0.560 | 0.146 | 0.053 | 0.054 | ||
(0.622) | (1.019) | (0.851) | (0.880) | |||||
Downward revision | −0.136 | −0.028 | −0.045 | −0.011 | −0.008 | −0.008 | ||
(−1.568) | (−0.374) | (−0.437) | (−0.443) | |||||
Industry fixed effects | Yes | Yes | – | – | – | |||
Firm and year fixed effects | – | – | Yes | Yes | Yes | |||
Observations | 3,256 | 3,256 | 2,225 | 3,256 | 3,256 | |||
Pseudo R2 / adj. R2 | 0.012 | 0.030 | 0.155 | 0.374 | 0.374 | |||
Ai and Norton marginal effect for Post ∗ Treat | −0.135*** | −0.136*** | – | – | – |
5.3 Threats to the identification and robustness tests
5.3.1 Pre-FAS 123R differences
Panel A: Pre-FAS 123R differences | ||||
Variable | Mean treated | Mean control | Difference | p value |
log(Market value) | 7.867 | 8.282 | −0.415*** | 0.001 |
Leverage | 0.168 | 0.169 | −0.001 | 0.947 |
Return on assets | 0.101 | 0.115 | −0.014* | 0.065 |
Book to market | 0.406 | 0.443 | −0.037 | 0.112 |
Sales growth | 1.127 | 1.124 | 0.003 | 0.868 |
Cash | 0.180 | 0.153 | 0.027* | 0.076 |
Investment growth | 0.140 | 0.129 | 0.011 | 0.816 |
Implicit claim | 0.478 | 0.437 | 0.041 | 0.167 |
Altman − Z | 5.546 | 6.001 | −0.455 | 0.306 |
Number estimate | 12.708 | 12.100 | 0.608 | 0.273 |
Observations | 1,382 | 160 | ||
Panel B: Propensity score matched sample | ||||
Column 1: Logit PSM | Column 2: OLS PSM | |||
Variable | Coeff. (Z-stat.) | Marginal effects | Coeff. (t-stat.) | |
Post | 0.105 | 0.020 | 0.016 | |
(0.333) | (0.331) | |||
Treat | 0.878*** | 0.106*** | 0.175*** | |
(2.890) | (2.672) | |||
Post * Treat | −1.187*** | −0.224** | −0.223*** | |
(−2.866) | (−2.998) | |||
Controls | Yes | Yes | ||
Industry fixed effects | Yes | Yes | ||
Observations | 574 | 574 | ||
Pseudo R2 / adj. R2 | 0.128 | 0.146 |
5.3.2 Parallel trends assumption
Panel A: Firm and year fixed effects difference-in-differences regressions of fundamentals | ||||
---|---|---|---|---|
Dependent variable | Post * Treat | t-stat. | adj. R2 | |
log(Market value) | 0.007 | 0.163 | 0.958 | |
Leverage | 0.012 | 1.237 | 0.783 | |
Return on assets | 0.003 | 0.571 | 0.786 | |
Sales growth | 0.018 | 0.752 | 0.386 | |
Cash | −0.003 | −0.356 | 0.887 | |
Investment growth | −0.023 | −0.335 | 0.246 | |
Implicit claim | 0.004 | 0.474 | 0.966 | |
Altman-Z | −0.170 | −0.597 | 0.834 | |
Number estimate | 0.072 | 0.217 | 0.876 | |
Panel B: Pseudo-events and other tests | ||||
\( Prob\left( Meet\ or\ beat\right)={\beta}_1 Post+{\beta}_2 Treat+{\beta}_3 Post\ast Treat+{\sum}_{k=1}^K{\beta}_{3+k}{Controls}_k+\varepsilon \) | ||||
Variable | Column 1: Pseudo event 2007 | Column 2: Control group 1 vs. Control group 2 | Column 3: Only control group 1 | Column 4: Only control group 2 |
Post | −0.006 (−0.115) | 0.010 (0.129) | 0.029 (0.532) | 0.031 (0.543) |
Treat | 0.037 (1.200) | 0.132 (1.340) | 0.141*** (2.928) | 0.142*** (2.805) |
Post * Treat | −0.009 (−0.183) | −0.037 (−0.353) | −0.131** (−2.322) | −0.132** (−2.199) |
Controls | Yes | Yes | Yes | Yes |
Industry fixed effects | Yes | Yes | Yes | Yes |
Observations | 3,445 | 310 | 3,097 | 3,105 |
Adj. R2 | 0.063 | 0.245 | 0.062 | 0.062 |
5.3.3 Further placebo tests
5.3.4 Other concerns
5.4 Further corroborating evidence
5.4.1 What channels do managers use to meet or beat targets?
\( Earnings\ management\ mechanims=\alpha +{\beta}_1 Post\ast Treat+{\sum}_{k=1}^K{\beta}_{3+k}{Controls}_k+\varepsilon \) | ||||||||
---|---|---|---|---|---|---|---|---|
Variable | Column 1: Discret. accruals | Column 2: Discret. asset sales | Column 3: Discret. sales manip. | Column 4: Discret. R&D | Column 5: Discret. SG&A | Column 6: Forecast walk down | Column 7: Opp. GAAP definition | Column 8: Restatements |
Post ∗ Treat | 0.006 | −0.003** | −0.059** | 0.003 | 0.003 | −0.055 | −0.004 | 0.029 |
(0.153) | (−2.026) | (−2.201) | (0.938) | (0.231) | (−0.243) | (−0.050) | (0.541) | |
log(Market value) | 0.031 | 0.000 | 0.028 | −0.007* | −0.058*** | 0.175 | −0.180* | −0.048 |
(0.580) | (0.166) | (0.828) | (−1.827) | (−3.757) | (0.599) | (−1.707) | (−0.683) | |
Book to market | 0.126 | −0.004 | 0.082 | −0.003 | −0.064** | −0.348 | −0.317 | −0.060 |
(1.143) | (−1.132) | (1.198) | (−0.318) | (−2.041) | (−0.585) | (−1.474) | (−0.420) | |
Sales growth | −0.003 | −0.001 | 0.286*** | 0.012** | 0.021 | 0.040 | −0.342** | −0.120 |
(−0.041) | (−0.502) | (5.424) | (2.040) | (0.905) | (0.091) | (−2.132) | (−1.125) | |
Dividend yield | −0.246 | −0.001 | 0.554* | −0.034 | −0.265* | 0.609 | 0.927 | 0.476 |
(−0.535) | (−0.034) | (1.789) | (−0.929) | (−1.831) | (0.223) | (0.939) | (0.725) | |
Net operating | 0.058 | 0.004*** | −0.180*** | 0.001 | −0.050*** | 0.018 | 0.252*** | 0.024 |
assets | (1.493) | (2.614) | (−5.477) | (0.230) | (−4.167) | (0.080) | (3.055) | (0.443) |
Shares | −0.000 | 0.000 | 0.000* | −0.000 | 0.000** | 0.001 | 0.001*** | 0.000 |
(−0.834) | (0.864) | (1.867) | (−0.527) | (2.345) | (0.755) | (2.600) | (0.005) | |
Implicit claim | 0.042 | −0.002 | −0.073 | 0.004 | −0.092* | −0.307 | 0.359 | 0.408* |
(0.259) | (−0.278) | (−0.589) | (0.339) | (−1.845) | (−0.325) | (1.049) | (1.793) | |
Number estimate | −0.000 | 0.000 | 0.005 | −0.000 | −0.001 | −0.026 | −0.011 | 0.002 |
(−0.055) | (1.629) | (1.559) | (−0.886) | (−0.654) | (−1.004) | (−1.160) | (0.382) | |
CV estimate | −0.083 | −0.002 | 0.012 | −0.006 | −0.071* | −8.633*** | −0.181 | −0.184 |
(−0.638) | (−0.311) | (0.140) | (−0.540) | (−1.735) | (−11.133) | (−0.646) | (−0.986) | |
Downward revision | 0.045* | −0.000 | 0.011 | −0.001 | −0.001 | −0.107 | 0.046 | 0.037 |
(1.869) | (−0.413) | (0.719) | (−0.305) | (−0.155) | (−0.816) | (0.976) | (1.185) | |
Firm and year fixed effects | Yes | Yes | Yes | Yes | Yes | Yes | Yes | Yes |
Observations | 357 | 398 | 380 | 420 | 415 | 419 | 420 | 420 |
Adj. R2 | 0.249 | 0.424 | 0.954 | 0.640 | 0.896 | 0.441 | 0.529 | 0.609 |