Lucky Directors

This post is by Lucian Bebchuk, Harvard Law School.

Yaniv Grinstein, Urs Peyer, and I just placed on SSRN a new paper, Lucky Directors. As in our earlier study released last month, Lucky CEOs, our approach is to focus on “lucky grants” awarded at the lowest price of the grant month.

A key finding of our new study is that opportunistic timing of option grants is not limited, as has been thus far assumed, to options granted to executives. Favorable timing that cannot be fully explained by mere luck has also taken place among grants awarded to outside directors.

We continue to work on the subject so any comments or reactions to our new study (as well as to the earlier Lucky CEOs study) would be most welcome.

The abstract of Lucky Directors runs as follows:

While prior empirical work and much public attention have focused on the opportunistic timing of executives’ grants, we provide in this paper evidence that outside directors’ option grants have also been favorably timed to an extent that cannot be fully explained by sheer luck. Examining the option grants provided by public firms to outside directors during 1996-2005, we find that:
• Out of all director grant events, 9% (and a higher percentage when events coinciding with annual meetings are excluded) were “lucky grant events” – falling on days with a stock price equal to a monthly low.
• We estimate that about 800 lucky grant events owed their status to opportunistic timing, and that about 460 firms and 1400 outside directors were associated with grant events produced by such timing.
• Opportunistic timing of director grants appears to have taken place in each of the economy’s 12 (Fama-French) industries other than utilities.
• The opportunistic timing of director grant events has been to a substantial extent the product of backdating and not merely spring-loading based on private information.
• The Sarbanes-Oxley Act (SOX) reduced the incidence but did not eliminate the opportunistic timing of directors’ grants.
• Director grant events were more likely to be lucky when the potential gains from such luck were larger; indeed, for a given firm or director, grant events were more likely to be lucky in months in which the difference between the median price and lowest price of the month was large.
• Directors’ luck and executives’ luck have been linked. Directors’ grant events were more likely to be lucky when executives and especially the CEO also received a grant on the same date. Grant events not coinciding with an award to executives were still more likely to be lucky when the CEO got a lucky grant in the current or preceding year.
• Grant events were more likely to be lucky when the firm had more entrenching provisions protecting insiders from the risk of removal.
• Grant events were more likely to be lucky when the board did not have a majority of independent directors.
• Directors’ luck has been persistent; a grant event was more likely to be lucky when the preceding director grant event was lucky as well.
• 3.8% of all grant events were super-lucky – defined as taking place at the lowest price of the calendar quarter – and we estimate that 4.6% of all firms participated in one or more super-lucky grants that owed their status to opportunistic timing.

Our results indicate that option grant practices might have involved some agency problems between outside directors and shareholders – and not only agency problems between executives and their boards – and are relevant for assessing the performance of outside directors and identifying the conditions under which such directors can best perform.

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