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Introduction of Equity-Based Compensation and Impact on Firm Policies

In: Corporate Governance in the US and Global Settings

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  • Ranjan D’Mello
  • Mercedes Miranda

Abstract

We investigate the impact of the creation of a new incentive structure for CEOs resulting from firms introducing equity-based compensation (EBC) as a means of paying top executives on policy decisions. Contrasting a firm’s stock and operating performance in the period the CEO is compensated with EBC (EBC period) and the period when EBC is not a component of the same executive’s pay (No EBC period) leads us to conclude that awarding stock options and restricted shares to executives is not associated with improved firm performance. However, firms initiate EBC after superior performance suggesting that CEOs are awarded compensation in this form as a reward for past performance. Firms have higher unsystematic and total risk levels in the EBC period suggesting EBC influences CEOs’ risk-taking behavior and reduces agency costs arising from managerial risk aversion. While there is no change in R&D expenses and cash ratios there is a decrease in capital expenditures in the EBC period, which is consistent with reduced overinvestment agency costs. Finally, leverage and payout ratios are similar in both periods implying that firms’ financing policy is not influenced by changes in CEOs’ compensation structure.

Suggested Citation

  • Ranjan D’Mello & Mercedes Miranda, 2014. "Introduction of Equity-Based Compensation and Impact on Firm Policies," Advances in Financial Economics, in: Corporate Governance in the US and Global Settings, volume 17, pages 153-192, Emerald Group Publishing Limited.
    • Handle: RePEc:eme:afeczz:s1569-373220140000017005
    DOI: 10.1108/S1569-373220140000017005
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    More about this item

    Keywords

    Equity-based compensation; executive compensation; firm performance; incentive alignment; G31; G34;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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