Option compensation is an important component of executive pay in the United States. By providing convex payoffs, option-based compensation is viewed as a standard mechanism to reduce manager risk aversion and align manager and shareholder interests by encouraging value-enhancing risk taking. In aligning manager-shareholder interests, chief executive officer (CEO) stock option compensation can also intensify conflicts of interests with other key stakeholders by encouraging potentially excessive firm risk taking (see, e.g., John and John, 1993; Opler and Titman, 1994; Kuang and Qin, 2013; Akins et al., 2019). In this study, we take a novel approach to further our understanding of the effects of these conflicts of interest by studying the impact of competitive shocks to important product market relationships and executive option compensation.

Generating sales and preserving valuable product market relationships, such as with major customers, is arguably one of the most crucial factors for a firm’s success. In the United States, nearly half of public firms depend on at least one large customer for a substantial portion of their sales, i.e., representing at least 10% of sales (Ellis, Fee, and Thomas, 2012). It is also common for firms to make relationship-specific investments (RSI) in their major customer relationships, and the health of these valuable trading relationships can significantly affect firm value. As a result, suppliers that depend on an important customer commonly state that the loss of a major customer would negatively impact their firm. For example, Scientific Atlanta Inc., a cable and telecommunications equipment manufacturer, states in its 2005 Form 10-K filing: “A failure to maintain our relationships with customers that make significant purchases of our products and services could harm our business and results of operations. A decline in revenue from one of our key customers or the loss of a key customer could have a material adverse effect on our business and results of operations.” Networking server and storage manufacturer Qlogic Corp. states in its 2005 10-K filing: “Any such reduction, delay or loss of [major customer] purchases could have a material adverse effect on our business, financial condition or results of operations.”

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