The underhand trick some CEOs use to boost their own wealth

Why would business leaders drive down the share price?

The underhand trick some CEOs use to boost their own wealth

The issue of executive compensation is often on the agenda for income equality advocates and corporate shareholders and a new study is likely to fuel further debate.

According to researchers at the University of Notre Dame, some CEOs release negative news about their companies in the period leading up to their executive stock option grant date.

This depresses the share price, meaning that they can buy their allocated number of stocks at a lower price, leading to major gains for CEOs of between U$143,500 and $839,000, depending on the assumptions.

“Incentive contracts are supposed to push an executive to increase the share price for stockholders,” says Tim Hubbard, the study’s author. “However, stock options have a unique period right before the grant date where CEOs are encouraged to lower their firm’s share price — this is the action that will create the most value for them personally.”

The study looked at option grants of US publicly traded companies from 2009 to 2013, examining the cumulative abnormal returns before option grant dates. The researchers collected all news releases from each firm during the period and used this data to understand whether firms release more negative news releases in this time frame and the type of negative news.

Underpaid CEOs more likely to do this
“When we examine which CEOs are most likely to try to use this mechanism to lower their stock price, we see that CEOs that are underpaid compared to their peers and those with significant discretion are more likely to release negative news during the period before the grant date, which lowers the stock price,” added Hubbard.

To guard against further gaming of the system, Hubbard recommends additional regulation and governance. He suggests giving option grants at more frequent intervals, such as monthly rather than yearly.

“Unintended Consequences: Information Releases and CEO Stock Option Grants,” is forthcoming in the Academy of Management Journal by Tim Hubbard, assistant professor of management in Notre Dame’s Mendoza College of Business and co-authors.