Misvaluation, CEO Equity-Based Compensation, and Corporate Governance
55 Pages Posted: 7 Nov 2007
Date Written: October 2007
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 Classification: G14, J33, G32
Suggested Citation: Suggested Citation