Issue of
August 11, 1999
 
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Executives time key
announcements to maximize stock-option values, study
finds
BY BY BARBARA BUELL
Every spring, a company's
shareholder prospectus uncovers the glut of salary and
stock options enjoyed by top corporate officers. There
has been suspicion, though little hard evidence, that
managers may actively try to boost the value of their
options before they are awarded. But recent research by
Graduate School of Business faculty member Ron Kasznik
reveals that some top executives do indeed manage the
timing of key company announcements, such as earnings
projections, to increase the worth of their awards.
Working with David Aboody,
assistant professor of accounting at UCLA's Anderson
Graduate School of Management, Kasznik has examined how
compensation incentives affect executives' decisions to
disclose information. Using data from 572 firms that
awarded options on almost the same dates year after year,
the researchers looked at the compensation for each
firm's chief executive officer over a five-year period
ending in 1996. In their examination of 2,039 scheduled
CEO stock option awards, they discovered that the pattern
of stock price movements, analyst forecast revisions and
management earnings forecasts around the time of the
awards is significantly different from the pattern
observed for these firms at other times. "This may
be the first time a link has been shown between CEOs' and
other top managers' compensation and the decision to
voluntarily disclose information," says Kasznik, who
is an assistant professor of accounting.
The researchers noticed
that stock price increases occurred after, rather than
before, the option award dates. "We also found that
before the award date they were more likely to disclose
bad news and they tended to wait with good news until
after the award date," says Kasznik. Rushing bad
news about lackluster earnings just before an option
award can push the stock price (and exercise price of the
option) down, thereby allowing a greater profit for the
executive when he exercises his option some time
laterassuming, of course, that stock prices continue to
rise.
Managing the market's
expectation for the stock downward can result in
significant CEO financial gains. The authors calculated
that for every $1 reduction in exercise price, the value
of each option increases by approximately 68 cents. On an
average CEO grant of 65,000 options, a single dollar
reduction in exercise price would reap a $44,200 gain.
The researchers found that the estimated gain was
particularly high among chief executives whose fixed
award dates preceded earnings announcements, providing
them with greater incentives to manage their voluntary
disclosures.
The study is relevant to
the huge growth in CEO compensation over the last two
decades, much of it in the form of skyrocketing stock
options. The percentage of chief executives receiving new
stock option grants increased from 30 percent in 1980 to
nearly 70 percent in 1994, report the authors. While
non-option compensation, such as salary and bonus, nearly
doubled to an average $1.3 million over that period, the
average estimated value of annual option awards grew six
times, from $200,000 to $1.2 million.
Aboody and Kasznik's
research was made possible by new Securities and Exchange
Commission disclosure rules issued in 1992. They require
more details about top executives' pay be made public
than had been available before. Proxy statements now
report an option's duration and expiration date, which
enabled the researchers to determine the exact date of
the stock option award, a key factor in their analysis.
Nearly all stock option awards are granted with a fixed
exercise price that equals the stock price on the date of
the award. Many companies also have a regular schedule
for awarding options to their top managers. That feature
allowed the researchers to test their hunch that CEOs
manage their disclosures, such as positive or negative
product and earnings forecasts. They screened out cases
in which top managers might have influenced the timing of
the awards themselves.
Playing with disclosure
dates does not seem to expose executives to the same
level of legal liability as other forms of insider
trading, says Kasznik. After all, a CEO may be able to
manipulate an option price lower, but it doesn't create a
profit until the option is exercised some time later.
There are no guarantees: The CEO might never profit if
the stock price goes south before the option can be
cashed out. "It's a gray area," says Kasznik.
One way to minimize CEOs'
incentive to manipulate disclosures in this way is to set
award dates after quarterly announcements, says Kasznik.
For now, the study sheds light on corporate disclosure
decisions, particularly related to voluntary disclosures
of bad news, and may also be of value to accountants and
compensation consultants who advise senior executives on
how to make the most of their compensation packages. SR
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