کاهش انگیزه مدیران برای تصمیمات با منافع بلندمدت: گزینه های سهام مدیریتی زمانیکه سهام داران، متنوع و گسترده می باشند

We analyze the relative advantage of option grants compared to stock compensation when shareholders are diversified. Our analysis recognizes a conflict that is largely neglected in the corporate finance literature. Shareholders want to maximize their portfolio value while capital budgeting rules direct managers to choose projects that maximize firm (equity) value. Options can reduce this conflict by motivating managers to avoid projects that enhance the value of one firm at the expense of another firm. Also, in our framework, relative performance evaluation destroys value for shareholders as it encourages firms to engage in cannibalistic activity. Consistent with the predictions of our model we find that firms with lower insider ownership, higher institutional ownership, and lower leverage tend to provide more option grants as compensation to their executives.

Much of the empirical and theoretical work in corporate finance employs the assumption that shareholders want to maximize the value of the firm’s equity and give managers incentives to do so. When investors are well-diversified but managers are relatively undiversified, however, the standard view of managerial compensation raises an important issue. Since investors hold diversified portfolios, they are concerned with firm value only through the value of the portfolio. Managers pursuing firm value maximization may not be acting optimally for investors if increases to some firm values are accompanied by decreases to the value of other firms in investors’ portfolios.1 In this paper, we examine how shareholders’ diversification2 affects the choice of managerial compensation when managers select the mix of projects that a company pursues, and when a company’s cashflow is affected by other companies’ actions. Our framework captures the idea that managers have discretion over project selection, and affect both the risk characteristics of the firm, and the ability of the firm to create (or destroy) value for shareholders. We show that the relation between riskiness of project and value creation/destruction for shareholders is central for the understanding of the complex relation between shareholders and managers. The kind of situation we have in mind can be described by the following example: Consider a pharmaceutical firm whose managers are faced with a choice between two projects that are mutually exclusive due to capital rationing or some other exogenous condition. One project involves developing a generic drug for a disease that is already treatable by a drug of a competitor company, whose patent life has expired. The other project involves research for a cure to an untreated disease. The first project will generate cashflow to the firm by reducing the cashflow of the competitor firm. The second project will increase the opportunity set of the economy, by generating cashflow that is incremental to the economy after considering the cashflows of other firms. In general, one might expect the second project to be riskier (i.e., a higher probability of failure, yet a high return in case of success).3 This means that diversified shareholders who hold many pharmaceutical firms in their portfolio should compensate managers in a way that promotes the second type of project because these are the projects that increase the value of their portfolio. In our model there are two firms and two non-diversified risk-neutral managers4 who decide on the projects to be selected in their respective firms. Each of the managers has a two-dimensional problem in choosing a mix of projects: the manager exerts cannibalistic effort and economy-increasing effort. The cannibalistic effort involves imposing a negative externality on the other firm. This would typically involve taking market share from the competitor firm in a mature market. In contrast, economy-increasing effort involves investing in new markets that enhance the opportunity set of shareholders after accounting for the effects on the competitor firm. 5 We also make the critical assumption that economy-increasing projects have greater total risk than cannibalistic projects. We do not want to be dogmatic about this assumption as there could be circumstances in which the reverse is true. However, we do perceive that in general there is more theoretical reasoning and empirical evidence that economy-increasing projects are the riskier type of projects. There is more uncertainty about the success/failure of the development of new products and markets. Typically these projects involve high research and development expenses and there is evidence that these are the riskiest sort of expenditures. 6 Our theoretical analysis concerns how commonly used compensation tools, namely stock and option grants; affect the value of a shareholder’s portfolio in a moral hazard setting. We do so by solving for the competitive Nash-equilibrium where shareholders set the compensation package in each firm independently; however, they do so realizing that their objective is to maximize their portfolio value and not the firm value. We show that when the firms in the economy are held by non-diversified shareholders (i.e., shareholders hold shares in only one of the two firms), the moral hazard problem of the shareholders can be solved by providing stock incentives. Under such circumstances, option compensation does not provide any benefits compared to stock incentives. Contrary to that, when the firm is held by diversified shareholders (i.e., shareholders hold shares in both firms) and the manager is provided stock incentives, the manager tends to exert a relatively large amount of cannibalistic effort even though diversified shareholders prefer that the manager would not engage in these types of projects. We show that option grant compensation results in a relatively greater loss in the manager’s payoff from cannibalistic effort than in the manager’s payoff from economy-increasing effort. This helps achieve the objective of diversified shareholders to shift the manager’s choice of effort towards relatively more economy-increasing effort and less cannibalistic effort. While Jensen and Meckling (1976) show that risk-shifting is a form of agency cost, in our model risk-shifting helps induce managers to engage in less cannibalistic projects. Our theoretical framework provides us with four testable hypotheses. H1: Insiders’, who typically hold non-diversified portfolios, would be reluctant to provide executives with option compensation as they can solve the moral hazard completely with stock incentives. We therefore hypothesize that a higher percentage of insiders’ holdings would lead to a lower use of option compensation to executives. H2: Institutional investors, who typically hold diversified portfolios, are better off by providing option grants to executives as it increases the relative effort exerted in economy-increasing projects and reduces cannibalistic activity between firms. We hypothesize that a higher percentage of institutional holdings would lead to higher use of option compensation. H3: Firms with high leverage are reluctant to use option compensation as leverage may result in an added conflict with debtholders. Even if some debtholders are the same individuals as the shareholders (i.e., diversified shareholders hold the market portfolio of debt and equity), debt would provide the risk-shifting incentive. Therefore, we hypothesize that higher leverage would lead to lower use of option compensation. H4: Relative performance evaluation leads to greater cannibalistic activity in the economy. Diversified shareholders would prefer that these types of compensations were not used and we hypothesize that they will not be observed in firms with a high percentage of institutional ownership.

Studies that focus on firm value maximization have as an underlying assumption that shareholders are not diversified and care about the value of one specific company. In this paper, we show that if shareholders are diversified, providing managers with incentives to maximize firm value may not be optimal for diversified shareholders. In our framework managers have discretion on project selections and affect the portfolio value of shareholders. We argue that in many instances the safer projects are those that destroy value for diversified shareholders. This means that compensating managers with options shifts managerial effort towards more of the projects that increase shareholder’s portfolio value and less of the projects that reduce portfolio value. Our model provides a plausible rationale for the inappropriateness of relative performance evaluation as it encourages zero-sum competition. It provides three other hypotheses concerning the relation between executive option compensation, ownership structure, and leverage. Non-diversified shareholders would be reluctant to provide executives with option compensation, while diversified shareholders would prefer it. Leverage should reduce the use of option compensation. The three hypotheses are confirmed in the empirical part of the paper. We find that insiders’ holding and leverage are negatively and significantly related to executive option compensation, while institutional holdings is positively and significantly related to option compensation.