Lucky CEOs

Yaniv Grinstein, Urs Peyer and I just issued a discussion paper, Lucky CEOs, on option backdating and corporate governance. The study has been covered in the Wall Street Journal, New York Times, Washington Post, Financial Times, and Boston Globe. We are continuing to work on the subject so any comments or reactions would be most welcome. Our abstract describes the paper as follows:

We study the relation between corporate governance and opportunistic option grant manipulation. Our methodology for studying grant manipulation focuses on how grant date prices rank within the price distribution of the grant month. Investigating the incidence of “lucky grants” — defined as grants given at the lowest price of the month – we estimate that about 1150 lucky grants resulted from manipulation and that 12% of firms provided one or more lucky grant due to manipulation during the period 1996-2005. Examining the circumstances and consequences of lucky grants we find:

– Lucky grants were more likely when the company did not have a majority of independent directors on the board and/or the CEO had longer tenure — factors that are both associated with increased influence of the CEO on pay-setting and board decision-making.

– Lucky grants were more likely to occur when the potential payoffs from such luck were high; indeed, even for the same CEO, grants were more likely to be lucky when granted in months in which the potential payoffs from manipulation were relatively higher.

– Luck was persistent: a CEO’s chance of getting a lucky grant increases when a preceding grant was lucky as well.

– In contrast to impressions produced by cases coming under scrutiny thus far, grant manipulation has not been primarily concentrated in new economy firms but rather has been widespread throughout the economy, with a significant incidence of manipulation in each of the economy’s 12 (Fama-French) industries.

– We find no evidence that gains from manipulated option grants served as a substitute for compensation paid through other sources; indeed, total reported compensation from such sources in firms providing lucky grants was higher.

– We estimate the average gain to CEOs from grants that were backdated to the lowest price of the month to exceed 20% of the reported value of the grant and to increase the CEO’s total reported compensation for the year by more than 10%.

– About 1,000 (43%) of the lucky grants were “super-lucky,” having been given at the lowest price not only of the month but also of the quarter, and we estimate that about 62% of them were manipulated.

– We identify certain pools of grants with an especially high probability of manipulation. For example, we identify a pool of 600 grants out of which 88% are estimated to be manipulated.

The full discussion paper is available for download here.