Misvaluation, CEO Equity-Based Compensation, and Corporate Governance

55 Pages Posted: 7 Nov 2007

See all articles by Joetta Forsyth

Joetta Forsyth

Pepperdine University - Graziadio School of Business and Management

Siew Hong Teoh

University of California, Irvine - Accounting Area

Yinglei Zhang

The Chinese University of Hong Kong (CUHK) - School of Accountancy

Date Written: 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 Classification: G14, J33, G32

Suggested Citation

Forsyth, Joetta and Teoh, Siew Hong and Zhang, Yinglei, Misvaluation, CEO Equity-Based Compensation, and Corporate Governance (October 2007). Available at SSRN: https://ssrn.com/abstract=1027341 or http://dx.doi.org/10.2139/ssrn.1027341

Joetta Forsyth

Pepperdine University - Graziadio School of Business and Management ( email )

Malibu, CA
United States

Siew Hong Teoh (Contact Author)

University of California, Irvine - Accounting Area ( email )

Irvine, CA 92697-3125
United States

Yinglei Zhang

The Chinese University of Hong Kong (CUHK) - School of Accountancy ( email )

Shatin, N.T.
Hong Kong

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