Incentive Effects of Illiquid Stock and Option Holdings of Target and Acquirer CEOS

45 Pages Posted: 27 Apr 2004

See all articles by Jie Cai

Jie Cai

Drexel University

Anand M. Vijh

University of Iowa - Department of Finance

Date Written: July 2004

Abstract

Due to a variety of liquidity constraints, CEOs of U.S. corporations hold highly undiversified portfolios of stock and options of their own firms. This results in an illiquidity discount, measured by the difference between the market value and the executive value of their holdings. We argue that acquisitions offer an effective mechanism for target CEOs to remove many liquidity constraints and reduce or eliminate the illiquidity discount. Following Shleifer and Vishny (2003), we further argue that for overvalued acquirer firms the acquisitions enable acquirer CEOs to improve the long-term value of their illiquid wealth. Using a sample of 250 acquisitions during 1993-2001, we document several incentive effects of illiquid stock and option holdings. Target CEOs who face higher illiquidity discount accept lower acquisition premium and are more likely to leave after the acquisition completes. They also put up lower resistance and speed up the acquisition. Similarly, acquirer CEOs who face higher illiquidity discount pay higher acquisition premium, speed up the acquisition, pursue relatively undervalued targets, and make multiple and diversifying acquisitions using stock payment.

Keywords: Mergers, acquisitions, managerial incentives, liquidity restrictions, stock and option holdings

JEL Classification: G34, M52, G32, J63

Suggested Citation

Cai, Jie and Vijh, Anand M., Incentive Effects of Illiquid Stock and Option Holdings of Target and Acquirer CEOS (July 2004). Available at SSRN: https://ssrn.com/abstract=536362 or http://dx.doi.org/10.2139/ssrn.536362

Jie Cai (Contact Author)

Drexel University ( email )

LeBow College of Business
Philadelphia, PA 19104
United States
215-895-1755 (Phone)
215-895-2955 (Fax)

HOME PAGE: http://faculty.lebow.drexel.edu/CaiJ/

Anand M. Vijh

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-0921 (Phone)
319-335-3609 (Fax)

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