NEW PUBLIC COMPANIES STOCK OPTION PLANS:
CHARACTERISTICS AND INCENTIVES
Robert H. Keeley
College of Business and Administration
University of Colorado at Colorado Springs
1420 Austin Buffs Parkway
Colorado Springs, CO 80933-7150
Tassaad A. Turki
Gordon M. Phillips
Krannert School of Management
1310 Krannert Building
West Lafayette. IN 47907-1310
While many studies have investigated the stock market performance of young firms at the time they go public, only a few studies have studied the long-run performance of these firms. Ritter (1989) investigates the long-run stock market performance of these firms and documents an important anomaly: these firms under perform, in terms of stock market returns, benchmarks of similar firms. This study takes a different approach. We seek to investigate whether differences in firms' compensation policy are associated with time- series and cross-sectional variation in performance measures.
We analyze several different measures of performance beginning with the long-run survival of the firm and extending to whether compensation policy is associated with success in the stock market. We thus extend studies by Murphy (1985) and Jensen and Murphy (1990) to a sample of initial public offerings. Similar to Murphy and Jensen and Murphy ,i.e. investigate the pay-performance relationship over a long-period of time. We extend these studies by examining long-run survival in addition to the pay-performance relationship for surviving firms because unlike large Fortune 500 companies a significant fraction of the firms in our initial sample are not in operation in the final year of our study.
The preliminary sample consists of the executive compensation data and company financial information for 23 companies that went public in 1983. These companies have either an SIC code of 35 (computer) or 36 (communication),
The data on executive compensation was collected from the annual proxy statements for the individuals named in the "Cash Compensation" table. In addition to cash compensation, which is usually defined as salary and bonus, we collected data on benefits such as company's contribution to individual's 401(k) Plan are benefits derived from the company's stock purchase plan. We also collected data on executives' stock ownership and granted stock options. The company financial information such as share price arid annual sales was collected from Compustat.
For the 23 companies in the preliminary sample, 12 have survived as of 1993. 2 have existed as separate entities for 8 years, 3 for 5 yeas. 3 for 4 years, 2 for 3 years and one for 2 years. The companies that did not survive as separate entities either merged, were acquired or went bankrupt. For the other companies, executive compensation was collected for 23 individual companies.
The preliminary results seem to indicate that the change in the cash compensation of a young company's CEO is not tied to the change in shareholder wealth as has been previously documented. for example in Jensen and Murphy (1990) and Murphy (1985). Even though the sign of the regression coefficient is positive, indicating that an increase in shareholder wealth leads to increase the CEO's cash compensation, the deficiency is not statistically significant.
These results are too preliminary to draw strong conclusions about executive performance and compensation in young companies. However, the above result is in line with the hypothesis that young companies may not be able to reward performance by of increase in cash compensation since young companies do not generally have the cash to do so. Also. the above result is consistent with the hypothesis that young companies usually resort to stock options as means of deferring present compensation, to some future date, have not yet valued the stock options granted to executives as part of their compensation to test this hypothesis,
Besides the obvious difficulties of valuing executive stock options. even for mature companies, the collected data seems to indicate that stock option valuation for young companies is even more challenging. The average tenure of an executive, as measured by the period over which the executive is named in the "Cash Compensation" table, for our sample is only two years with a median tenure of 2 years. Most stock option plans have an average vesture period of 5 years. With hindsight, it appears that stock options not be an important component of an executive's total compensation. If this result is confirmed, it will have a major impact on the ability of young companies to attract and retain key executives.
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