Are Executive Stock Option Exercises Driven by Private Information?

33 Pages Posted: 16 May 2006

See all articles by David Aboody

David Aboody

University of California, Los Angeles (UCLA) - Accounting Area

John S. Hughes

University of California at Los Angeles

Jing Liu

The Cheung Kong Graduate School of Business

Date Written: April 26, 2006

Abstract

We examine the extent to which executive stock option exercises may be driven by private information. Contrary to the maintained assumption in prior literature that all shares acquired though exercises are immediately sold, we found that no shares are sold within thirty days following approximately half of the exercises. Generally speaking, we find strong evidence that executives are exploiting positive private information when they exercise the options but hold the shares beyond thirty days, and weaker evidence that they are exploiting negative private information when they exercise the options and sell the shares within thirty days. To increase the power of tests, especially on the negative side, we consider several factors that may be important to executives when making exercise decisions. Along with the exploitation of private information, these include dividend and tax incentives to exercise early, opportunity costs of early exercise due to the loss of time value in options, and reduction of diversifiable risk and concomitant disguise in potential law suits offered by claims of diversification when options are deeply in the money. We find strong evidence that executive's trading gains are positively correlated with time value and depth. Further findings support the conclusion that executives exploit positive private information by holding options as well as by exercising options and holding the shares.

Keywords: stock option, private information

JEL Classification: J33, D82, G12, G13, G14

Suggested Citation

Aboody, David and Hughes, John S. and Liu, Jing, Are Executive Stock Option Exercises Driven by Private Information? (April 26, 2006). Available at SSRN: https://ssrn.com/abstract=900860 or http://dx.doi.org/10.2139/ssrn.900860

David Aboody (Contact Author)

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
310-825-3393 (Phone)
310-267-2193 (Fax)

John S. Hughes

University of California at Los Angeles ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
310-794-9553 (Phone)
310-267-2193 (Fax)

Jing Liu

The Cheung Kong Graduate School of Business ( email )

1 East Changan Avenue, Oriental Plaza
E3/3F
Beijing
China

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