Companies approve a stock option plan to attract, retain, and motivate the CEOs and other top management on the behalf of shareholders. Thus, stock option awards are designed as a mechanism to align the interests of managers and shareholders. However, there is a controversy over whether executive stock option awards induce opportunistic managerial behavior which is adverse to shareholders interests, and this issue has been extensively investigated in academic work for the last decade. In this study, we attempt to provide further evidence on the role of stock options as a compensation scheme on the firm.
Almost all U.S. firms use at-the-money stock options to compensate CEOs and other top management that is managers’ exercise price (strike price) is set to the grant-date market price. In this case, managers may have incentive to engage in opportunistic behavior around the grant date and the exercise date. In particularly, managers wish to lower exercise price around the grant date and to raise the market price around the exercise date so that they can maximize their benefit. Yermack (1997) is the first paper to investigate managers’ influence over the terms of their own compensation and find that CEOs opportunistically time option-grant dates around earnings announcements to increase their compensation. Aboody and Kasznik (2000) employ the sample with fixed award schedules to suggest that CEOs time their voluntary disclosures around grant date; Lie (2005) use unscheduled awards sample to suggest that CEOs time their awards retroactively. Carpenter and Remmers (2001), Huddart and Lang (2003), and Bartov and Mohanram (2004) investigate managerial incentive for option exercises with mixed results.
Though previous studies investigate this issue, we propose alternative possibility that managers communicate with analysts to manage investors’ expectations and the stock market. Managers may prefer to use the release of analyst’s information to manipulate the market reaction instead of management information disclosure or timing awards retroactively. Since 1940s, shareholders can file lawsuits against managers as managers mislead market by disseminating adverse information (Francis et al., 1994) according to rule 10b-5 of the 1934 Securities Exchange Act.
Under this situation, managers have to bear legal exposure and litigation costs. Further, they have to bear the cost of reputation loss as investors and shareholders recognize their manipulation behaviors. Given the concerns of media and investors with executive stock option grants, managers would rather employ other indirect methods such as analyst’s information than direct methods such as management voluntarily information disclosure and backdating to achieve the same purpose.