Investor pricing of CEO equity incentives
Jeff P. Boone
Inder K. Khurana
K. K. Raman
Published online: 20 June 2010
Ó Springer Science+Business Media, LLC 2010
Abstract The main purpose of this paper is to explore CEO compensation in the form of
stock and options. The objective of CEO compensation is to better align CEO-shareholder
interests by inducing CEOs to make more optimal (albeit risky) investment decisions.
However, recent research suggests that these incentives have a signiﬁcant down-side (i.e.,
they motivate executives to manipulate reported earnings and lower information quality).
Given the conﬂict between the positive CEO-shareholder incentive alignment effect and
the dysfunctional information quality effect, it is an open empirical question whether CEO
equity incentives increase ﬁrm value. We examine whether CEO equity incentives are
priced in the ﬁrm-speciﬁc ex ante equity risk premium over the 1992–2007 time period.
Our analysis controls for two potential structural changes over this time period. The ﬁrst is
the 1995 Delaware Supreme Court ruling which increased protection from takeovers (and
decreased risk) for Delaware incorporated ﬁrms. The second is the 2002 Sarbanes–Oxley
Act which impacted corporate risk taking, equity incentives, and earnings management.
Collectively, our ﬁndings suggest that CEO equity incentives, despite being associated
with lower information quality, increase ﬁrm value through a cost of equity capital
Keywords CEO equity incentives Á Information quality Á Cost of equity capital
JEL Classiﬁcation M41 Á M52
J. P. Boone
Department of Accounting, College of Business Administration, University of Texas at San Antonio,
San Antonio, TX 78249, USA
I. K. Khurana
School of Accountancy, University of Missouri-Columbia, Columbia, MO 65211, USA
K. K. Raman (&)
Department of Accounting, College of Business Administration, University of North Texas,
P. O. Box 305219, Denton, TX 76203, USA
Rev Quant Finan Acc (2011) 36:417–435