CEO Stock Ownership Policies—Rhetoric and Reality

The following post comes to us from Nitzan Shilon at Peking University School of Transnational Law. This post is based on his recent study, CEO Stock Ownership Policies—Rhetoric and Reality. He conducted this study while being a Fellow in Law and Economics and an S.J.D. (Doctor of Laws) candidate at Harvard Law School.

I recently published a study titled CEO Stock Ownership Policies—Rhetoric and Reality. This study is the first academic endeavor to analyze the efficacy and transparency of stock ownership policies (SOPs) in U.S. public firms. SOPs generally require managers to hold some of their firms’ stock for the long term. Although firms universally adopted these policies and promoted them as a key element in their mitigation of risk, no one has shown that such policies actually achieve the important goals that they have been established to achieve. My study shows that while SOPs are important in theory, they are paper tigers in practice. It also shows that firms camouflage the weakness of these policies in their public filings. Therefore I put forward a proposal to make SOPs transparent as a first step in improving their content. My findings have important implications for the ongoing policy debates on corporate governance and executive compensation.

Below is a more detailed account of my analysis:

Since the 2008–09 financial crisis, regulators, firms, investors, and practitioners around the world have been trying to ensure that executive pay arrangements in public firms discourage managers from taking excessive risks and pursuing short-term gains at the expense of long-term value. In particular, shareholders have pushed firms to adopt SOPs, which require senior executives and directors to hold a minimum dollar value of their firms’ stock until retirement and, in some cases, thereafter. In addition to shareholder pressure to adopt SOPs, the federal government has prescribed strict SOPs for TARP firms, prominent public officials have emphasized the importance of SOPs, business leaders have stressed the need for them, and proxy-voting firms have rewarded firms for adopting them. As a result, SOPs have become universal, reaching a 95% prevalence rate among the top 250 U.S. public firms.

Firms have adopted SOPs to attain several very important goals. One such goal is to align the interests of managers with those of their long-term shareholders. When SOPs tie managers’ personal wealth to their firms’ long-term value, managers have greater incentives to maximize such value. Consistent with this theory, in a response to Facebook cofounder and CEO Mark Zuckerberg’s announcement on September 4, 2012, that he would keep his Facebook stock until at least the next year, Facebook’s stock price rose by 5%.

A second goal is to discourage excessive risk taking. The theory is that without SOPs, managers might have incentives to elevate their firms’ risk and increase stock price volatility. With higher volatility in stock price, such managers can expect either to profit by pocketing greater amounts if they hold on to their stock while the price increases or to avoid losses by quickly selling their stock before the price plummets.

A third goal is to discourage managers from sacrificing the long term for the short term. Without SOPs, managers might be tempted to take actions that would boost the stock price in the short term, even if those actions would pile up latent and excessive risk of an implosion later on―assuming they could unload their stock before such an implosion occurs. Bebchuk, Cohen and Spamann’s study [1] suggests that such incentives played a role in the risk-taking decisions of the top five executives at Bear Stearns and Lehman Brothers during the years preceding their firms’ meltdowns in 2008.

However, using statistical analyses of quantitative and qualitative data disclosed in proxy statements of firms included in the S&P 500, I show that SOPs are extremely ineffectual in making CEOs hold on to their firms’ stock; in fact, they typically allow CEOs to unload virtually all of their vested stock whenever they wish. For example, the SOP of UPS would not prevent its CEO, Scott Davis, from immediately selling all his vested UPS stock—worth over $30 million—should he choose to do so. Moreover, a recent study shows that most top executives take full advantage of their freedom to unload their firms’ stock and engage in massive stock selling. [2]

My research indicates that the ineffectiveness of SOPs is driven by their design. First, firms generally allow their managers to count their unvested stock (stock that they do not yet own) to satisfy their SOP requirements. Second, the average SOP sets its target stock-holding threshold lower than 50% of a single year’s total compensation. Third, these policies usually allow CEOs to take five years to attain the required stock thresholds. Finally, SOPs commonly do not specify the sanctions for breaching them, which might suggest that these policies are merely advisory.

In addition to the extreme ineffectiveness of SOPs—and certainly more troubling—is the lack of transparency as firms camouflage the weakness of these policies in their public filings. In particular, not a single firm discloses big-picture indicators of policy weakness, such as the amount of stock managers are allowed to unload immediately and the amount they have already unloaded. Firms also fail to disclose some critical terms of their SOPs, such as counting policies, phase-in periods, and sanctions. Consequently, investors are unable to know whether the SOPs fulfill their purpose. The philosophy of U.S. securities regulations is to facilitate informed and intelligent decision making by investors. But investors simply do not have credible and detailed information about the functionality of SOPs, and because they cannot assess these policies accurately, they are unable to make informed decisions as to whether and how the policies should be improved.

It is worth noting that the fact that SOP ineffectiveness is camouflaged suggests that their weakness is undesirable. Otherwise, disclosure of that weakness would be a selling point used to increase stock price and firm value. However, since firms are unable to justify the weakness of their policies, they hide it.

Shareholders believe that SOPs are at least sometimes desirable, so they push firms to adopt them; proxy-voting firms back up shareholders and reward firms for having SOPs; and firms adopt SOPs, declaring that their purpose is to attain important goals. However, declaring that SOPs are adopted to attain important goals and then camouflaging their inability to achieve those goals creates confusion and sends mixed messages.

A possible explanation for why SOPs are extremely ineffective and why that ineffectiveness is camouflaged is that managers have excessive power vis-à-vis shareholders. By misleading the markets into believing that managers’ interests are better aligned with the interests of long-term shareholders, that managers no longer have incentives to take excessive risks, and that boards are not feckless, SOP camouflage helps managers gain unjustified reputational benefits while allowing them to avoid incurring the personal diversification and liquidity costs associated with having effective SOPs. Finally, SOP camouflage makes it unlikely that outsiders will exert pressure on firms to make their SOPs more effective, which would, of course, force executives to incur the costs they seek to avoid.

My findings indicate that SOPs are unlikely to affect managers’ incentives and behavior. This, in turn, makes these policies incapable of achieving the important goals they were established to attain. Not achieving such goals comes at the shareholders’ expense because their managers’ interests remain unaligned with their own.

To remedy these flaws, I propose a regulatory reform to make SOPs transparent. In particular, I propose reforming the rules that govern public firms’ filings with the SEC pursuant to Regulation S-K. With specific quantitative measures to gauge SOP bottom-line efficacy, as well as certain qualitative measures that focus on the functioning of SOP design, I believe that boards and shareholders―assisted by proxy advisors, executive compensation advisors, and practitioners―will be able to identify and remedy the flaws inherent in their SOPs.

The full study is available for download here.


[1] See Lucian A. Bebchuk, Alma Cohen & Holger Spamann, The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000–2008, 27 Yale J. on Reg. 257, 260 (2010).
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[2] See Tomislav Ladika, Do Firms Replenish Executives’ Incentives After Equity Sales? 2 (Sept. 8, 2013) (unpublished manuscript), available at
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