Lucky Directors

Abstract

The analysis of this paper was subsequently combined with that of our companion paper “Lucky CEOs,” http://ssrn.com/abstract=945392. The combined paper, titled “Lucky CEOs and Lucky Directors,” is available on SSRN at http://ssrn.com/abstract=1405316 and was published at Journal of Finance, Vol. 65, No. 6, pp. 2363-2401, 2010.

While prior work has focused on the opportunistic timing of executives' grants, we provide in this paper evidence that outside directors' option grants have also been favorably timed to an extent that cannot be fully explained by sheer luck. Examining events in which public firms granted options to outside directors during 1996-2005, we find that 9% of director grant events were lucky grant events falling on days with a stock price equal to a monthly low. We estimate that about 800 lucky grant events owed their status to opportunistic timing, and that about 460 firms and 1400 outside directors were associated with grant events produced by such timing. Director grant events were preceded by negative abnormal returns and followed by positive abnormal returns. There is evidence that the opportunistic timing of director grant events has been to a substantial extent the product of backdating and not merely spring-loading based on private information. We find that directors' luck has been correlated with executives' luck. We also find that director grant events were more likely to be lucky when the potential gains from such luck were larger, when the firm had more entrenching provisions protecting insiders from the risk of removal, and when the board did not have a majority of independent directors.

Because our analysis suggests that the existence of lucky director grants is a variable that can be useful to research studying firms’ governance and decision-making, we make available on the website of the Harvard Program on Corporate Governance a dataset of director luck indicators based on our work.

Keywords: Executive compensation, corporate governance, stock options, backdating, spring loading, inside information, CEO, independent directors, outside directors, entrenchment

JEL Classification: D23, G32, G38, J33, J44, K22, M14