Executive Compensation Structure and Corporate Equity Financing Decisions

Abstract

Building on Myers and Majluf's (1984) model, we propose that the magnitude of the market response to seasoned equity offering (SEO) announcements depends on the degree of alignment between the goals of managers and existing shareholders. We document a negative relation between the stock market response to SEO announcements and equity-based compensation (EC) awarded to issuing firm managers. The evidence suggests that the market perceives high EC managers as issuing more-overvalued equity (relative to low EC managers), which benefits existing shareholders and exacerbates the adverse selection problem for potential new shareholders. The relation between EC and the market reaction to SEOs varies cross-sectionally with (a) information asymmetry, (b) investment opportunities, (c) pre-issue stock price run-up, and (d) managerial ownership. Our study highlights the importance of a cohesive executive compensation policy and corporate financing policy.

Keywords: Executive compensation, Financing, Equity offering, SEOs

JEL Classification: G30, G32