When is Enough, Enough? Market Reaction to Highly Dilutive Stock Option Plans and the Subsequent Impact on CEO Compensation

46 Pages Posted: 9 Aug 2002

See all articles by Kenneth J. Martin

Kenneth J. Martin

New Mexico State University - Department of Finance & Business Law

Randall S. Thomas

Vanderbilt University - Law School; European Corporate Governance Institute (ECGI)

Date Written: March 24, 2002

Abstract

Early studies of market reaction to stock option plans have found positive increases in stock prices upon the announcement of these plans. However, since in the mid-1990's, shareholders have become increasingly critical of stock option plans, and voted against them in growing numbers. Are shareholders fed up with the continued growth in option compensation, and if so, what are boards of directors doing in response to these concerns?

In this paper, we use data from the 1998 proxy season to reevaluate market reaction to management-sponsored proposals for stock option plans, the level of shareholder opposition to these plans, and the effect of this opposition on corporate boards' awards of CEO compensation in subsequent years. In the first half of the paper, we conduct an event study similar to those done for early stock option plans from the 1980's and early 1990's. However, we expect to find that the market will react differently to plans that exhibit the high levels of potential dilution of shareholder ownership and certain "shareholder unfriendly" aspects of the plans that make shareholders more likely to vote against such plans. Our findings support part of our hypothesis: we find that higher levels of potential dilution in executive-only plans result in significantly negative cumulative market adjusted returns in the 3-day period surrounding the proxy date, but that plans that include repricing provisions, permit executives to borrow money from the firm in order to exercise options, or that allow the issuance of restricted stock, do not experience significantly negative returns.

In the second part of the paper, we present evidence regarding the factors that affect shareholder voting opposition to stock option plans and the impact of this opposition on subsequent CEO compensation. In cross-sectional regressions, we find a significantly negative relationship between the percentage vote against the option proposal and the percentage change in salary and in total pay from the 1999 to 1998 compensation years. We interpret this finding to support the idea that boards of directors respond to shareholder concerns about CEO option awards by reducing executive pay in the year after a high level of shareholder opposition.

Suggested Citation

Martin, Kenneth J. and Thomas, Randall S., When is Enough, Enough? Market Reaction to Highly Dilutive Stock Option Plans and the Subsequent Impact on CEO Compensation (March 24, 2002). Journal of Corporate Finance, Vol. 11, p. 61, 2005, Vanderbilt Law and Economics Research Paper No. 03-06, Available at SSRN: https://ssrn.com/abstract=321424 or http://dx.doi.org/10.2139/ssrn.321424

Kenneth J. Martin

New Mexico State University - Department of Finance & Business Law ( email )

College of Business Administration & Economics
Las Cruces, NM 88003
United States
505-646-3201 (Phone)
505-646-2820 (Fax)

Randall S. Thomas (Contact Author)

Vanderbilt University - Law School ( email )

131 21st Avenue South
Nashville, TN 37203-1181
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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