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Misvaluation, CEO Equity-Based Compensation, and Corporate Governance
Joetta Forsyth Pepperdine Graziadio School of Business Siew Hong Teoh University of California - Paul Merage School of Business Yinglei Zhang Chinese University of Hong Kong (CUHK) - School of Accountancy October 2007 Abstract: We investigate empirically whether mispricing of a firm's stock affects CEO equity-based compensation, controlling for industry and year effects, economic determinants, board characteristics, and institutional ownership. We hypothesize that an overvalued firm may award higher grants to meet the manager's reservation utility from another job, to maintain performance incentives, to acquiesce to greater rent extraction, or to reduce the likelihood of paying for luck. Among firms that award stock options, we find that CEOs of overvalued firms receive higher stock option compensation, lower cash compensation and higher overall total compensation. Furthermore, we find that when a firm awards higher option grants in response to overvaluation or because of a weak board, it subsequently underperforms more. However, the firm subsequently overperforms when it awards more option grants because it has high growth prospects or a high fraction of institutional shareholders.
Keywords: corporate governance, misvaluation, compensation JEL Classifications: G14, J33, G32 Working Paper SeriesDate posted: November 07, 2007 ; Last revised: December 19, 2007Suggested CitationContact Information
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