Out-of-the-Money CEOs: Inferring Private Control Premium from CEO Option Exercise

OMI Seminar Series

This study explores how CEOs' private benefits of control manifest themselves in option exercises. We document two salient patterns: The rate at which CEOs exercise vested options in order to sell (or hold) the resulting shares slows down by 80% (or accelerates by 50%) when a proxy contest is looming, consistent with CEO's desire to maintain or strengthen their voting rights when facing control challenges. Moreover, such distortions are closely aligned with the institutional details unique to proxy contests, such as the record dates and director nomination status. In extreme cases, the presence of a proxy contest triples the probability that an insider exercises call options out-of-the money, a strategy deemed unambiguously irrational under the conventional models. The various forms of distortions imply sizable incumbents' private valuation premium on the order of 3% to over 20% of stock price. Additional tests arm the connection between the deviations from normal exercise behavior and a control motive, which is distinct from other motives documented in the literature including diversification, inside information about future stock prices, and behavioral factors such as overconfidence.

Joint work with Vyacheslav Fos (Illinois).

Tuesday, May 13, 2014 - 12:30
to 13:30