Changes in CEO Stock Option Grants: A Look at the Numbers

Vasiliki Athanasakou is Assistant Professor of Accounting at the London School of Economics; Daniel Ferreira is Professor of Finance at the London School of Economics; and Lisa Goh is Assistant Professor of Accounting at Hang Seng Management College. This post is based on their recent paper.

In our paper, Changes in CEO Stock Option Grants: A Look at the Numbers, we look at changes in stock option granting behavior towards CEOs. We find that, on average, the number of stock option grants to CEOs changes over time, and that such changes can be predicted by CEO corporate investment decisions; CEOs of firms that have very high or very low levels of investment subsequently receive fewer stock options.

We focus on the number of stock options granted to CEOs. We know relatively little about how the number of options granted changes over time, and how this varies across firms, even though regulators and investors often focus their attention on the number of stock options granted. For example, under current NYSE listing requirements, companies need only to obtain shareholder approval for the total number of options to be granted, and not for the value of these options. Consistent with this focus, patterns in option pay, such as the rigidity of annual stock option grants, and the high correlation of CEO pay with stock market indices (Shue and Townsend 2017), suggest that boards also think of option compensation in terms of numbers of options granted. It is natural for boards to focus on the number of options granted, as this is the main item over which they can actually exercise control. Nevertheless, academic research mainly focuses on the dollar value of stock option grants. Our paper examines option-granting behavior using the number of options granted as the main outcome variable. Do boards grant the same number of options to CEOs each year, or do they revise their granting behavior? What factors drive changes in stock option grants?

Most of the existing research on CEO compensation contracts is based on some form of the standard principal-agent model with moral hazard, in which boards design optimal compensation contracts to align CEO and shareholder interests. However, this assumes that boards know the preferences of the CEO. But what if CEOs’ preferences are not known (Ross 2004)? In such cases, boards have to learn about CEOs by observing their decisions, and then adjust compensation parameters accordingly (see e.g. Gibbons and Murphy (1992)). Learning about CEO preferences thus implies compensation structures that are always changing.

We find that CEOs who make either very high or very low levels of investment receive fewer stock options in the subsequent period. Regardless of the reasons, boards seem to adopt a cautious approach by reducing the flow of stock option grants to the CEO. Why might that be? To interpret our results, we consider theories of corporate investment decisions.

The traditional agency view suggests that a rational self-interested CEO may either overinvest (e.g. empire building) or underinvest (e.g. prefer a “quiet life”) relative to the optimal investment level if she is not sufficiently incentivized through equity-based compensation. However, in one variation of the traditional agency view, high-powered equity incentives can instead induce CEOs to prefer short-termist actions, which may lead to either underinvestment, or overinvestment. In this case, overinvestment or underinvestment is a consequence of too much equity-based compensation.

A second family of theories emphasizes CEO behavioral traits. For example, consider a CEO who is overconfident about his or her abilities. An overconfident CEO may place too much weight on his or her own information, and typically overinvests or underinvests relative to industry norms. According to this hypothesis, both overinvestment and underinvestment may reflect a CEO who is over-incentivized.

In light of these different theories, a board of directors that is imperfectly informed about its CEO’s preferences—a board that doesn’t know the strength of the CEO’s bias, risk aversion, or information acquisition costs—may learn about the CEO’s preferences by observing his or her investment choices. If it sees either underinvestment or overinvestment, a board that subscribes to the traditional agency view may increase CEO equity incentives to restore optimal incentive levels. A board that views high or low investment as evidence of CEO short-termism may reduce CEO equity incentives to rebalance the compensation package. Finally, a board that views high or low investment as evidence of CEO overconfidence should decrease CEO equity incentives. These theoretical views are neither exhaustive nor mutually exclusive, but represent three key possibilities that help us interpret our empirical results. Our findings that We propose and implement two different approaches for dealing with generated regressor problems. CEOs of firms making either high or low levels of investment receive fewer stock options in subsequent periods is not consistent with the traditional agency story, in which under-incentivized CEOs become either slackers or empire-builders. Rather, our findings are more consistent with boards being concerned about CEO short-termism or CEO overconfidence, and the potential detrimental effects of high CEO equity incentives. Boards may prefer to err on the side of caution when adjusting CEO compensation in response to evidence of either high investment or low investment.

We further find that CEO overconfidence (using Malmendier and Tate’s (2005) measure) is associated with fewer option grants, lending support to the overconfidence hypothesis. We also find that CEOs who overinvest subsequently receive more cash-based compensation (salary and bonus), suggesting that the reduction in stock options is part of an attempt to rebalance CEO compensation.

Our paper documents changes in compensation patterns after periods of overinvestment and underinvestment. Our evidence can inform theoretical discussions on the topic, and can be used to impose discipline on different theoretical frameworks. Our paper also helps to improve our understanding of re-contracting in executive compensation. While efficiency in the design of compensation schemes is a central theme in recent governance debates, there is little empirical evidence of feedback effects from firm outcomes, such as investment, to compensation design. By looking both at investment and CEO overconfidence, we show that alongside the “hard” evidence of corporate investment, boards also consider dynamic changes in the “softer” nature of CEO characteristics.

The complete paper is available for download here.


Gibbons, R, and K. J. Murphy. (1992). Optimal incentive contracts in the presence of career concerns: Theory and evidence. Journal of Political Economy 100(3): 468-505.

Malmendier, U., and G. Tate. (2005). CEO overconfidence and corporate investment. Journal of Finance 60(6): 2661-2700.

Ross, S. A. (2004). Compensation, incentives, and the duality of risk aversion and riskiness. Journal of Finance 59(1): 207-225.

Shue, K., and R. R. Townsend. (2017). Growth through rigidity: An explanation for the rise in CEO pay. Journal of Financial Economics 123(1): 1-21.

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