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Executive stock ownership and stock option pay are often assumed to have congruent incentive effects; however, these incentives have asymmetrical risk properties, and executives may respond to them in different ways. This study, which examined the effects of ownership and option pay, showed that they had diametrically opposite effects on firms' acquisition and divestiture propensity. Moreover, situational characteristics moderated the risk-seeking behavior associated with stock option pay but not the risk aversion associated with ownership.
The past two decades have witnessed an increase in the use and the levels of executive stock option pay and a call for greater levels of executive stock ownership among large U.S. firms (Jarrell, 1993; Lublin, 1998; Westphal & Zajac, 1994; Yermack, 1995). Stock option pay now averages close to 40 percent of total CEO pay (Forbes, 1998), and increasing numbers of firms are requiring their top executives to own significant amounts of firm stock (Gogoi, 1999). Many agency theorists (Baker, Jensen, & Murphy, 1990; Eaton & Rosen, 1983; Mehran, 1995; Shleifer & Vishny, 1997), management scholars (Hrebiniak & Joyce, 1983), and pay consultants (O'Byrne, 1992) advocate stock-based incentives because they reward executives for creating shareholder value. This incentive alignment hypothesis suggests that boards can use stockbased incentives to discourage managerial opportunism, promote shareholder-wealth-maximizing behaviors, and achieve higher levels of firm performance (Jensen & Meckling, 1976; Jensen & Murphy, 1990; Marcus, 1981). The stock market appears to anticipate and positively value the purported benefits of stock-based incentives (Westphal, 1999).
Nevertheless, some scholars have questioned whether incentives actually work as prescribed. For instance, Donaldson and Lorsch (1983) argued that the incentive alignment logic is based on simplistic assumptions about how executives make decisions. Others have raised questions about whether top executives really base changes in how they manage firms on the form of their incentives (Andrews, 1987; Finkelstein & Hambrick, 1996). Finally, although research on executive financial incentives has proliferated, most of that research has focused on the association between firm performance and compensation levels (Barkema & Gomez-Mejia, 1998; Finkelstein & Hambrick, 1996). Thus, there is little direct empirical evidence regarding the effects of stock-based financial incentives (Finkelstein & Hambrick, 1996; Murphy, 1999). Therefore, my first goal in this research was to examine behavioral effects of stock-based financial incentives by...