Executive Stock Incentives and Corporate Payout Policy: How do executive stock incentives affect payouts, and can they be used to mitigate the free cash flow problem?
Abstract: Using data on 849 companies included in the S&P 1500 Index during 2015-2019, this study provides an overview of how executive held shares and stock options affect companies' payout policies. By examining how executive stock incentives relate to the magnitude and composition of payouts, we aim to establish whether such incentives can be utilized to mitigate the free cash flow problem defined by Jensen (1986). Our primary findings suggest that agency problems are present while showing weak or no indications of executive stock incentives having a mitigating effect on the free cash flow problem. The results show strong links between executive stock incentives and the composition of payouts. We observe a positive relationship between executive share ownership and dividends, which could be explained by dividends' liquidity benefits and under-diversified executives' desire to reduce their exposure to their employer. Moreover, executive held options correlate positively (negatively) with repurchases (dividends), potentially explained by the fact that executive stock options are rarely dividend protected and repurchases are used to reach the target payout level by offsetting the option-caused decrease in dividends. Executive stock option ownership might also create a bias toward repurchases as that form of payout counter the dilutive effect of option grants and increase earnings per share.
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