Unintended Consequences: Information Releases and CEO Stock Option Grants

Abstract

Scholars, regulators, and practitioners have long struggled with challenges emanating from the separation of ownership and control of modern corporations. Agency theory typically prescribes the use of stock options, or other outcome-based contractual arrangements, to overcome the critical issue of information asymmetry. We theorize that this arrangement, which leaves information asymmetry in place, provides CEOs an informational advantage that can be used, via impression management techniques, to circumvent some of the intended benefits of option grants. Specifically, we argue that the period leading up to an option grant creates a scenario where CEOs are incentivized to reduce the stock price of their firm for personal gain. Our results suggest that CEOs respond to this incentive by adjusting the tenor of releases from the firm during the pregrant period, providing CEOs a substantial economic gain. We also show that underpaid CEOs and CEOs with higher discretion pursue this activity more frequently. Our findings highlight a critical challenge of agency theory: if information asymmetry remains, a motivated CEO can often circumvent the contractual arrangements intended to mitigate that very problem. We offer future research paths and practical recommendations to address this issue.

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