Stock Options and Internal Capital Allocation Decisions
This paper examines how executive stock options affect firmsΓÇÖ internal capital allocation decisions.┬á I find evidence at both the segment level and the firm level that conglomerate CEOs respond to option incentives by tilting toward high-risk segments when allocating capital expenditures across segments, which is consistent with the risk-seeking incentives associated with the convex payoff structure of options.┬á The results also suggest that corporate governance, as reflected in an index of anti-takeover amendments, has a substantial impact on firmsΓÇÖ investment choices.┬á
Aggarwal, R. K., & Samwick, A. A. (1999). The other side of the trade-off: The impact of risk on executive compensation. Journal of Political Economy, 107(1), 65-105.
Almazan, A., Hartzell J. C., & Starks, L. T. (2005). Active institutional shareholders and costs of monitoring: evidence from executive compensation. Financial Management, 34(4), 5-34.
Billett, M. T., & Mauer, D. C. (2003). Cross subsidies, external financing constraints, and the contribution of the internal capital market to firm value. Review of Financial Studies, 16(4), 1167-1201.
Cohen, R. B., Hall, B. J., & Viceria, L. M. (2000). Do executive stock options encourage risk-taking? Working Paper, Harvard Business School.
Coles, J. L., Daniel, N. D., & Naveen, L. (2006). Managerial incentives and risk-taking. Journal of Financial Economics, 79(2), 431-468.
Core, J. E., Holthausen, R. W., & Larker, D. F. (1999). Corporate governance, chief executive officer compensation, and firm performance. Journal of Financial Economics, 51(3), 371ΓÇô406.
Cremers, K. J. M., & Nair, V. B. (2005), Governance mechanisms and equity prices. Journal of Finance, 60(6), 2859-2894.
Daniel, N. D., Martin, J. S., & Naveen, L. (2004). The hidden cost of managerial incentives: evidence from the bond and stock markets. Working Paper.
DeFusco, R., Johnson, R., & Zorn, T. (1990). The Effect of Executive Stock Option Plans on Stockholders and Bondholders. The Journal of Finance, 45(2), 617-627.
Fama, E. F., & French, K. R. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), 153-193.
Gompers, P. A., Ishii, J. L., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118(1), 107-156.
Guay, W. R. (1999). The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants. Journal of Financial Economics, 53(1), 43-71.
Hartzell, J. C., & Starks, L. T. (2003). Institutional investors and executive compensation. Journal of Finance, 58(6), 2351-2374.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
Jin, L. (2002). CEO compensation, diversification, and incentives. Journal of Financial Economics, 66(1), 29-63.
Ju, N., Leland, H., & Senbet, L. W. (2014). Options, option repricing in managerial compensation: Their effects on corporate investment risk. Journal of Corporate Finance, 29(C), 628-643.
Kaplan, S. N., & Zingales, L. (1997). Do investment-cash flow sensitivities provide useful measures of financing constraints? Quarterly Journal of Economics, 112(1), 169-215.
Kayhan, A., & Titman, S. (2007). Firms' histories and their capital structures. Journal of Financial Economics, 83(1), 1-32.
Masulis, R. W., Wang, C., & Xie, F. (2007). Corporate governance and acquirer returns. Journal of Finance, 62(4), 1851-1889.
Meyer, M., Milgrom, P., & Roberts, J. (1992). Organizational prospects, influence costs, and ownership changes. Journal of Economics and Management Strategy, 1(1), 9-35.
Milgrom, P. (1988). Employment contracts, influence activities, and efficient organization design. Journal of Political Economy, 96(1), 42-60.
Milgrom, P., & Roberts, J. (1988). An economic approach to influence activities in organizations. American Journal of Sociology, 94(s1), 154-179.
Myers, S. C. (1977). The determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147-175.
Rajan, R. G., Servaes, H., & Zingales, L. (2000). The cost of diversity: The diversification discount and inefficient investment. Journal of Finance, 55(1), 35-80.
Ross, S. (2004). Compensation, incentives, and the duality of risk aversion and riskiness. Journal of Finance 59(1), 207ΓÇô225.
Scharfstein, D. S. (1998). The dark side of internal capital markets II: evidence from diversified conglomerates. NBER working paper 6352.
Scharfstein, D. S., & Stein, J. C. (2000). The dark side of internal capital markets: divisional rent-seeking and inefficient investment. Journal of Finance, 55(6), 2537-2564.
Shin, H., & Stulz, R. M. (1998). Are internal capital markets efficient? Quarterly Journal of Economics, 113(2), 531-552.
Smith, C., & Watts, R. (1992). The investment opportunity set and corporate financing, dividend, and financing policies. Journal of Financial Economics, 32(3), 263-292.
Wulf, J. (2009). Influence and inefficiency in the internal capital market. Journal of Economic Behavior & Organization, 72(1), 305-321.
Xue, Y. (2007). Make or buy new technology: a CEO compensation contractΓÇÖs role in a firmΓÇÖs route to innovation. Review of Accounting Studies, 12(4), 659-690.
Yermack, D. (1995). Do corporations award CEO stock-options effectively? Journal of Financial Economics, 39(2-3), 237-269.
Authors who publish with this journal agree to the following terms:
- Authors retain copyright and grant the journal right of first publication with the work simultaneously licensed under a Creative Commons Attribution License that allows others to share the work with an acknowledgement of the work's authorship and initial publication in this journal.
- Authors are able to enter into separate, additional contractual arrangements for the non-exclusive distribution of the journal's published version of the work (e.g., post it to an institutional repository or publish it in a book), with an acknowledgement of its initial publication in this journal.
- Authors are permitted and encouraged to post their work online (e.g., in institutional repositories or on their website) prior to and during the submission process, as it can lead to productive exchanges, as well as earlier and greater citation of published work (See The Effect of Open Access).