Do Managers Influence their Pay? Evidence from Stock Price Reversals Around Executive Option Grants by M.P. Narayanan, Hasan Seyhun

SSRN-Do Managers Influence their Pay? Evidence from Stock Price Reversals Around Executive Option Grants by M.P. Narayanan, Hasan Seyhun: "Consistent with the hypothesis that managers influence their pay, the reversals are positively related to grant size and the seniority of the manager, and negatively related to the firm size. "

The size of this reversal is staggering.

"The market-adjusted return for the 90 days preceding the grant date is about −3.6% and the return for the 90 days following the grant date is about 9.4%. In small firms, the 90-day post-grant date average abnormal rise in stock price is about 17%. These patterns are significantly larger than any that has been documented in previous literature."

I saw this and, while surprised by the size, held off reading the rest of the article because I feared it was the same old thing on the topic: namely that managers do influence their pay by issuing bad news prior to option grant dates and good news after (see Yermack 1997). Well, that part was found again. BUT, what is cool about this paper is that the Narayanan and Seyhun propose that the price reversals that are found around option grant dates might not be merely because of the timing of news releases, but the selection of historic dates to use as the option grant date.

From the paper:

"consistent with the back-date method of influencing the grant date stock price comes from the relationship between stock price reversals on the grant date and reporting lags....for most of our sample period, Section 16(a) of the Securities and Exchange Act requires that option grants be disclosed within 10 days of the month following the month of the grant. About two-thirds of the awards in our database are reported after this deadline. We define the number of days elapsed between the grant date and the reporting date the “reporting lag.” If indeed in some cases the grant date is set on a back-date basis, the reporting period is extended automatically by an amount equal to the elapsed time between the reported grant date and the date on which the grant decision was made. Therefore, if the stock return reversals of Figure 1 are caused partly by awards being given on a back-date basis, the reversals should be more pronounced (i.e., the drop before and the rise after the grant date should both be steeper) in those cases where the reporting lag is greater. This is exactly what we find."

Why the interpretation of back-dating? Because of the striking change of direction around the date is almost too much to believe:

"if managers attempt to drive the share price down before the grant date by selling shares of the firm that they own and then release favorable earnings information after the grant date, it will be most likely in violation of the anti-fraud provisions of the Securities and Exchange Act of 1934 [Section 10(b)-5]. For these reasons, it appears farfetched that managers are influencing the stock price with such precision to obtain options at a reduced exercise price."

With that in mind, the authors look for (and find) evidence that is consistent with backdating. For instance, the reversal is greater for larger grants, grants to more senior management, and that there is no abnormal return when the actual grant is announced.

Interesting stuff!

Cite:
Narayanan, M.P. and Seyhun, Hasan Nejat, "Do Managers Influence their Pay? Evidence from Stock Price Reversals Around Executive Option Grants" (January 2005). http://ssrn.com/abstract=649804