Do executive stock options reduce agency problems between managers and stockholders?

Date

1999-08

Journal Title

Journal ISSN

Volume Title

Publisher

Texas Tech University

Abstract

Agency problems that arise in a corporation have troubled economists for some time. There are a number of mechanisms that have been used to try and reduce these agency problems. Many of these mechanisms try to link the manager's compensation to the performance of the firm. Typical examples include performance shares, restricted stock grants, and executive stock options. This dissertation is an empirical study of whether the use of executive stock options has in fact reduced the agency problems between managers and stockholders.

In this dissertation, two different testing methodologies are used to address the agency problem reduction issue. One methodology looks at some significant event such as a merger or divestiture to see if an executive's holding of stock options affect what decisions are made. For example, do larger holdings of stock options motivate managers to take on riskier investments? By increasing the risk of the firm, managers can increase the value of the stock options. Another question of interest is whether in taking on risky investments; do executives increase the leverage of the firm? By increasing the leverage of the firm, the executive might increase the risk of the firm and thus the value of the option holdings. For NYSE executives, stock options do not appear to be motivating them to act in the hypothesized behavior. For the NASDAQ manager, the evidence seems to indicate that they are acting in the hypothesized manner.

The other methodology takes a different approach. In it, a broad cross-section of firms is examined to see if there is a relationship between firm variance and executive stock option holdings. The cross-sectional results seem to be indicative of a strong positive relationship (which is predicted by the hypotheses of interest) between firm variance and stock option holdings. The results are the same regardless of whether NYSE or NASDAQ firms are considered. Overall, most of the evidence from this dissertation supports the notion that executive stock options aid in the reduction of agency problems between top executives and stockholders.

Description

Keywords

Executives -- Salaries etc. -- United States, Agency (Law) -- United States, Employee stock options -- United States, Employee motivation -- United States, Corporations -- Finance

Citation