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Investor Pricing of CEO Equity IncentivesJeff P. BooneUniversity of Texas at San Antonio - Department of Accounting Inder K. KhuranaUniversity of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business KK RamanUniversity of Texas at San Antonio June 16, 2010 Review of Quantitative Finance and Accounting, Vol. 36, No. 3, pp. 417-435, April 2011 Abstract: The objective of CEO compensation is to better align CEO-shareholder interests by inducing CEOs to make more optimal (albeit risky) investment decisions. However, recent research suggests that these incentives have a significant down-side(i.e., they motivate executives to manipulate reported earnings and lower information quality). Given the conflict between the positive CEO-shareholder incentive alignment effect and the dysfunctional information quality effect, it is an open empirical question whether CEO equity incentives increase firm value. We examine whether CEO equity incentives are priced in the firm-specific ex ante equity risk premium over the 1992-2007 time period. Our analysis controls for two potential structural changes over this time period. The first is the 1995 Delaware Supreme Court ruling which increased protection from takeovers (and decreased risk) for Delaware incorporated firms. The second is the 2002 Sarbanes Oxley Act which impacted corporate risk taking, equity incentives, and earnings management. Collectively, our findings suggest that CEO equity incentives, despite being associated with lower information quality, increase firm value through a cost of equity capital channel.
Keywords: CEO Equity Incentives, Information Quality, Cost of Equity Capital JEL Classification: M41, M52 Accepted Paper SeriesDate posted: June 16, 2010 ; Last revised: April 24, 2011Suggested CitationContact Information
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