Executive Stock Option Repricing, Internal Governance Mechanisms, and Management Turnover

What Drives Executive Stock Option Backdating?

“…Therefore, we expect a higher growth opportunity to increase the propensity for option backdating. Profitability : return on assets is a ratio of EBIT (Earnings Before Interest and Taxes) to total assets. Prior studies suggest that option repricing is associated with poor prior performance (Carter and Lynch, ; Chidambaran and Prabhala, ). For retention purposes, we hypothesize that firms with poor prior performance tend to backdate options. Industry : to capture the industry‐specific effects, we follow Chidambaran and Prabhala () and create three industry dummy variables .…”

“…Prior studies suggest that option repricing is associated with poor prior performance (Carter and Lynch, ; Chidambaran and Prabhala, ). For retention purposes, we hypothesize that firms with poor prior performance tend to backdate options. Industry : to capture the industry‐specific effects, we follow Chidambaran and Prabhala () and create three industry dummy variables . In addition, we use 2‐digit SIC codes to control for the industry fixed effects more generally.…”

“…In addition, we use 2‐digit SIC codes to control for the industry fixed effects more generally. Chidambaran and Prabhala () find that firms in the technology, trade and service industries tend to reprice options. Carter and Lynch () argue that high‐technology firms are more likely to be situated in a competitive labor market and thus face higher managerial turnover.…”

“…Chidambaran and Prabhala () find that higher executive option holdings (not share ownership) are associated with higher option repricing while Chen () finds that higher CEO share ownership (not option holdings) decreases the likelihood of adopting repricing restrictions. Ex‐post , Sauer and Sautner () find that performance improves significantly after repricing.…”

“…When executives have large option holdings relative to their direct equity ownership, the need for option repricing is higher because of the misalignment in incentives when facing downside risk and/or simply because it is valuable to do so (Chidambaran and Prabhala, ). Therefore, we hypothesize that executive option holdings are positively related to backdating. Out‐of‐Moneyness : the literature on option repricing (e.g., Carter and Lynch, ; Chidambaran and Prabhala, ) suggests that option repricing is positively associated with the out‐of‐moneyness (OOM) of existing executive option portfolios for the purpose of restoring weak incentives. Instead of applying the full‐information method (FI), the typical method in the repricing literature, which might require up to 10 years of historical proxy statements to perfectly identify the required characteristics of CEO option portfolios for Black and Scholes valuations, we follow Core and Guay's () 1‐year approximation method (OA) which requires information from the most recent proxy statement only.…”