Can CEO equity‐based compensation limit investment‐related agency problems?

Xin Qu · Majella Percy · Fang Hu

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Corporate Finance and Governance Auditing, Earnings Management, Governance Accounting and Organizational Management

Abstract

Abstract Previous research suggests that investment‐cash flow sensitivity (ICS) has arisen from agency costs. This study investigates whether equity‐based compensation (EBC) reduces these costs. We find that ICS is lower when companies grant EBC to chief executive officers (CEOs). EBC with long‐term vesting periods, and especially with graded vesting conditions, is associated with a lower ICS. EBC with performance hurdles is associated with higher sensitivity. However, when the performance hurdles are set as a relative market index rather than an absolute target, the sensitivity becomes lower. Our results suggest that appropriately designed EBC plays an important role in mitigating investment‐related agency problems.

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References

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