Article Preview
Top1. Introduction And Literature Review
Executive Stock options (ESOPs), give managers and employees of a company the right to buy a share of stock at a pre-specified exercise price for a pre-specified period. ESOPs have emerged as the single largest component of compensation for executives as well for workers worldwide1. Employee retention is the most-often cited objective for stock option plans; according to Ittner, Lambert, and Larcker (2003) the objectives of company stock option plans are to help the company attract, retain, and motivate its executives and other employees. Other motives may be rewards for achieving specific milestones and goals, and attracting new employees. Compensation in the form of stock options rather than cash allows companies to conserve cash while reducing reported accounting expense2, and allows recipients to defer taxable income until exercise or even later.
Stock options could be of smaller capital market importance if they were not tradable3. Executives tend to exercise their options early and sell the shares. Barracloughet. al. (2012) adjust stock options in the event of unexpected corporate actions to see whether the result of the adjustment will be gains or losses. They show that when the dividend is announced, the absolute adjustment in the U.S. and Canada minimizes the windfall change in option valuewhile the adjustment in Australia and Europe depends on stock price and is therefore vulnerable to temporary aberrations in the stock market.
Corbella and Florio (2010) examine stock options in Italy on the basis of the dominant accounting principles (GAAP and IFRS) in the country and conclude that the aforementioned difference cannot be explained with each system’s conceptual framework, indicating that focus on weaknesses must be given to the national GAAP.
Aboody et al (2008) who examined executive stock options in US companies from 1996 to 2003, found that shares are held over thirty days following over a quarter of options exercised. Factors potentially affecting early exercise is the liquidity needs of the executive Robicheaux, Fu, and Ligon (2008), or diversification needs, Liu and Yermack (2007), Fu and Ligon (2010). A number of studies, among which Carpenter and Remmers (2001), Huddart and Lang (2003)Brooks, et. al. (2009) attribute early exercise to insider information, whilst part of research (Carpenter and Remmers (2001) and Aboody et al (2008))indicates that executive option exercises as a whole do not indicate any negative private information. More recent studies seem to conclude that whilst non-executive stock options are good, executive stock options are not necessarily good news for the company. In particular, Hochberg and Lindsey (2010) examined the sensitivity of the firm’s outstanding non-executive options, per employee and found that it leads to an increase in the underlying value of a firm’s stock. On the other side, Collins et al. (2009), examined US firms from 1998 to 2004 and found weak corporate governance as a contributing factor to increasing ESOP issuance whilst Dong et al (2010) who examined stock option offerings by US public companies from 1993 to 2007 found that managers are more likely to use debt than equity as a capital-raising vehicle when their wealth is more sensitive to stock return volatility. This result is intuitive, since compared to equity financing, debt financing increases firm leverage and stock return volatility, and thus managers with a higher volatility gain more from a debt issue.