JESSE M. FRIED, University of California, Berkeley - School of Law
Email: FRIEDJ@MAIL.LAW.BERKELEY.EDU

Despite recent reforms, public company executives can still use inside information to time their stock sales, secretly boosting their pay. They can also still inflate the stock price before selling. Such insider trading and price manipulation imposes large costs on shareholders. This paper suggests that executives' options be cashed out according to a pre-specified, gradual schedule. These hands-off options would substantially reduce the costs associated with current equity arrangements while imposing little burden on executives.

MARTIN LIPTON, Wachtell, Lipton, Rosen & Katz
Email: mlipton@wlrk.com

This memorandum highlights some of the significant issues that boards of directors of U.S. companies face in 2008, including tremendous pressures to realize short-term stock-market gains at the expense of long-term value. These pressures have become acute as hedge funds and other activist shareholders, as well as influential proxy advisory firms, have sought to reshape the landscape in ways that undermine the board-centric model of governance. In addition, this memorandum highlights some issues and practical considerations for directors to bear in mind in reviewing the roles, duties and procedures of boards and board committees.

JENNIFER N. CARPENTER, New York University - Department of Finance
Email: jcarpen0@stern.nyu.edu
RICHARD STANTON, University of California, Berkeley - Finance Group
Email: stanton@haas.berkeley.edu
NANCY WALLACE, University of California, Berkeley - Real Estate Group
Email: wallace@haas.berkeley.edu

Options have become a major component of corporate compensation. Their cost to firms depends on the exercise policies of executives who face hedging constraints. This paper analyzes the optimal policy and option cost for an executive with general concave utility. We show analytically how the policy and cost vary with risk aversion, wealth, and dividend, and when there exists a single stock price boundary. We also provide an example with a split continuation region, and numerical results on volatility and beta effects. Option value decreases with risk aversion, increases with wealth and hedging opportunities, but can actually decline with volatility.

THOMAS H. NOE, Oxford (SBS and Balliol)
Email: thomas.noe@sbs.ox.ac.uk
MICHAEL J. REBELLO, University of Texas at Dallas - School of Management
Email: mrebello@gsu.edu

We model long-run firm performance, management compensation, and corporate governance in a dynamic, nonstationary world. We show that the relations between firm performance, managerial compensation, and governance policies, which in a single-period context can best be rationalized by managerial influence, arise naturally in this dynamic setting where managers have no power over governance policy. For example, passive "do-nothing" boards are associated with rising firm valuations; substantial variation in management pay is generated by luck; managerial diversion of firm resources for private consumption is likely to accompany stock price declines which immediately follow sustained increases. Further, the threat of corporate control changes can adversely affect firm value, and incentive compensation schemes such as stock grants may not produce as much shareholder value as simple salary compensation. Finally, we demonstrate that optimal governance and compensation structures are highly dependent on the firm's asset base, its legal environment, and the effectiveness of the corporate control market.

GAVIN SMITH, University of New South Wales - School of Banking and Finance
Email: gavinsmith@student.unsw.edu.au
PETER L. SWAN, UNSW
Email: peter.swan@unsw.edu.au

CEO flow incentives, both stock options and bonuses, are positively related to measures of firm market valuation and operating performance suggesting incentives are an important mechanism to align CEO interests with shareholders. These findings are robust to alternative measures of firm valuation and operating performance. They are also persistent across various estimation techniques such as pooled OLS with clustered standard errors, firm random effects, and firm fixed effects and also after accounting for potential endogeneity between compensation and firm performance as well as firm heterogeneity. Providing CEOs with increased equity and bonus incentives in their annual compensation is the "road to riches" for owners of a firm.

LUCIAN ARYE BEBCHUK, Harvard Law School, National Bureau of Economic Research (NBER)
Email: bebchuk@law.harvard.edu
MARTIJN CREMERS, Yale School of Management
Email: martijn.cremers@yale.edu
URS PEYER, INSEAD - Finance
Email: urs.peyer@insead.edu

We investigate the relationship between CEO centrality -- the relative importance of the CEO within the top executive team in terms of ability, contribution, or power -- and the value and behavior of public firms. Our proxy for CEO centrality is the fraction of the top-five compensation captured by the CEO. We find that CEO centrality is negatively associated with firm value (as measured by industry-adjusted Tobin's Q). Greater CEO centrality is also correlated with (i) lower (industry-adjusted) accounting profitability, (ii) lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, (iii) higher odds of the CEO's receiving a 'lucky' option grant at the lowest price of the month, (iv) greater tendency to reward the CEO for luck in the form of positive industry-wide shocks, (v) lower likelihood of CEO turnover controlling for performance, and (vi) lower firm-specific variability of stock returns over time. Overall, our results indicate that differences in CEO centrality are an aspect of firm management and governance that deserves the attention of researchers.

KONSTANTINOS TZIOUMIS, London School of Economics (LSE)
Email: k.tzioumis@lse.ac.uk
RAFAEL GOMEZ, London School of Economics & Political Science (LSE) - Interdisciplinary Institute of Management
Email: r.gomez@lse.ac.uk

In this paper we estimate the relation between union presence within a firm and CEO compensation, using a unique panel of publicly listed companies for the period 1992 to 2001. We find that, on average, union presence: 1) is significantly associated with lower levels of total CEO compensation; 2) affects the mix of CEO compensation by providing higher levels of base pay but much lower stock option values; 3) lowers dispersion across the major components of CEO remuneration and 4) does not significantly reduce the performance sensitivity of CEO compensation as compared to non-union firms. These results are consistent with several models of union influence.