Underwater Options and the Dynamics of Executive Pay-to-Performance Sensitivities

We empirically analyze the dynamics of executives' pay-to-performance sensitivities. Option pay-to-performance sensitivities become weaker as options fall underwater, often leading to pressures to reprice options or restore pay-to-performance sensitivity in other ways. Building a detailed data...

Full description

Saved in:
Bibliographic Details
Published in:Journal of accounting research 2004-05, Vol.42 (2), p.365-412
Main Authors: HALL, BRIAN J., KNOX, THOMAS A.
Format: Article
Language:English
Subjects:
Accounting
Business structures
Coefficients
Effects
Executive compensation
Firm theory
Management
Market portfolios
Nasdaq Composite Index
Pay for performance
Price elasticity
Repricing
Statistical median
Stock options
Stock prices
Stock shares
Stocks
Strike prices
Studies
Wages
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:We empirically analyze the dynamics of executives' pay-to-performance sensitivities. Option pay-to-performance sensitivities become weaker as options fall underwater, often leading to pressures to reprice options or restore pay-to-performance sensitivity in other ways. Building a detailed data set on executives' portfolios of stock and options, we find that the responsiveness of pay-to-performance sensitivities (created by all executive holdings of stock and options) to changes in stock price is large. The elasticity of pay-to-performance sensitivities with respect to stock price decreases is about 0.7 and is larger for high-option executives and for executives with high percentages of options already underwater. The dominant mechanism through which companies offset declines in option pay-to-performance sensitivities is larger option grants following stock price declines; on average, these larger grants restore approximately 40% of the stock-price-induced pay-to-performance sensitivity declines. Option repricings are inconsequential in this regard, despite the attention they have attracted. In looking at positive returns, we find the reverse: higher returns both directly increase pay-to-performance sensitivities and lead to larger option grants, which raise pay-to-performance sensitivities further. Thus, option grants to executives tend to be largest following large stock price increases or large stock price decreases.
ISSN:0021-8456
1475-679X
DOI:10.1111/j.1475-679X.2004.00142.x