CEOs are motivated by opportunities to pad their personal bottom lines, even when taking advantage of them can be expected to harm the companies they lead, two new research papers suggest.
The studies establish a link between the amount of a CEO’s awarded equity — stock and stock options — that vests in a particular quarter, and corporate actions in that quarter that boost short-term stock prices but destroy long-term value.
Such actions include revising guidance upward, reducing R&D and capital expenditures, buying back shares, and making acquisitions.
“The research paints a clear and bold portrait of short-termism, with concern for long-term value creation faded into the background,” says Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute, which named the two papers as co-winners of its annual investor research competition.
One of the papers finds that periods of heavy vesting coincide with reduced investment in long-term projects. More broadly, the paper shows that the structure of CEO compensation has a causal effect on corporate decisions.
For example, a one-standard-deviation increase in a CFO’s vesting equity in a particular quarter is associated with an annualized 0.2% decrease in the growth of R&D plus net capital expenditures, scaled by total assets. That decline represents 11% of the average investment-to-assets ratio, according to the paper.
The same level of increase in vesting equity is associated with a $140,000 rise in the average CEO’s equity sales in that quarter.
The paper’s authors are Alex Edmans of London Business School, Vivian Fang of the University of Minnesota, and Katharina Lewellen of Dartmouth College.
The other paper establishes that two particular corporate actions, stock repurchases and acquisitions, are both associated with higher short-term returns and lower long-term returns. Edmans and Fang co-authored this research as well, along with Allen Huang of Hong Kong University of Science and Technology.
The paper finds that a one-standard-deviation increase in a CEO’s vesting equity is associated with a 1.2% increase in a company’s likelihood of a conducting a share repurchase during the quarter. In dollar terms, the increase is $1.5 million for the average company.
Similarly, that level of increase in vesting equity is associated with a 0.6% increase in the likelihood that a company will announce an acquisition during the quarter.
The authors also give a vivid example of how a company can use an acquisition to boost its short-term stock price at the expense of negative long-term consequences.
In 2012, social software and data analytics company Bazaarvoice acquired competitor PowerReviews, which sent the acquirer’s stock price soaring. Bazaarvoice officers and directors then sold $90 million of stock, after which the Justice Department commenced an antitrust lawsuit that caused the stock to plummet.
In internal communications, Bazaarvoice executives stated that their motivation for the acquisition was eliminating the company’s primary competitor, leaving it with “literally, no other competitors.” That suggests the executives likely knew that a DoJ lawsuit, leading to negative long-term return, would be probable.
IRRC claims that the papers are the first to closely examine the structure of CEO equity vesting schedules and correlate them to value-creating or value-destroying corporate activities.
“Many views on executive pay, and thus calls for reform, are based on hand-picked anecdotes rather than large-scale evidence,” says Edmans. “While reformers often target the level of pay, our research suggests that the horizon of pay is a more important dimension.”