Introduction of Equity-Based Compensation and Impact on Firm Policies

Abstract

We investigate the impact of the creation of a new incentive structure for CEOs resulting from firms introducing equity-based compensation (EBC) as a means of paying top executives on policy decisions. Contrasting a firm’s stock and operating performance in the period the CEO is compensated with EBC (EBC period) and the period when EBC is not a component of the same executive’s pay (No EBC period) leads us to conclude that awarding stock options and restricted shares to executives is not associated with improved firm performance. However, firms initiate EBC after superior performance suggesting that CEOs are awarded compensation in this form as a reward for past performance. Firms have higher unsystematic and total risk levels in the EBC period suggesting EBC influences CEOs’ risk-taking behavior and reduces agency costs arising from managerial risk aversion. While there is no change in R&D expenses and cash ratios there is a decrease in capital expenditures in the EBC period, which is consistent with reduced overinvestment agency costs. Finally, leverage and payout ratios are similar in both periods implying that firms’ financing policy is not influenced by changes in CEOs’ compensation structure.

Citation

D’Mello, R. and Miranda, M. (2014), "Introduction of Equity-Based Compensation and Impact on Firm Policies", Corporate Governance in the US and Global Settings (Advances in Financial Economics, Vol. 17), Emerald Group Publishing Limited, Leeds, pp. 153-192. https://doi.org/10.1108/S1569-373220140000017005