Incentive Effects of Stock and Option Holdings of Target and Acquirer CEOs

Acquisitions enable target chief executive officers (CEOs) to remove liquidity restrictions on stock and option holdings and diminish the illiquidity discount. Acquisitions also enable acquirer CEOs to improve the long-term value of overvalued holdings. Examining all firms during 1993 to 2001, we show that CEOs with higher holdings (illiquidity discount) are more likely to make acquisitions (get acquired). Further, in 250 completed acquisitions, target CEOs with a higher illiquidity discount accept a lower premium, offer less resistance, and more often leave after acquisition. Similarly, acquirer CEOs with higher holdings pay a higher premium, expedite the process, and make diversifying acquisitions using stock payment. CORPORATE ACQUISITIONS ARE IMPORTANT RESTRUCTURING EVENTS as judged by their wealth creation and redistribution effects. Andrade, Mitchell, and Stafford (2001) report that 4,256 publicly traded firms in the U.S. economy were acquired by other publicly traded firms during 1973–1998. These acquisitions resulted in average announcement-to-completion wealth gains of 23.8% to target shareholders, −3.8% to acquirer shareholders, and 1.9% to combined shareholders. A large part of the acquisition activity occurs in waves, and they document that the recent wave of 1990s was quite big. Casual observation suggests that this period was also characterized by an increase in the stock and option holdings of chief executive officers (CEOs). This paper analyzes the incentive effects of stock and option holdings of target and acquirer CEOs in corporate acquisitions. In the case of target CEOs, our motivation comes from a growing literature that documents the adverse effect of illiquidity on personal valuation of securities. Meulbroek (2001), Hall and Murphy (2002), Cai and Vijh (2005), and many others show that the executive value of a firm’s stock and option holdings can be much lower than the market ∗Cai is from the LeBow College of Business at Drexel University and Vijh is from the Tippie College of Business at the University of Iowa. We have benefited from presentations at the University of Iowa, Drexel University, the Federal Deposit Insurance Corporation meetings, the Financial Management Association meetings, Fordham University, the Hong Kong University of Science and Technology, Iowa State University, Suffolk University, the University of Central Florida, the University of Kentucky, the University of Nebraska, and Wilfrid Laurier University. We wish to thank Matt Billett, Ben Esty, Jon Garfinkel, Todd Houge, and Erik Lie for useful comments. We are especially obliged to an anonymous referee, an associate editor, and Rob Stambaugh (the editor) for many insightful comments that substantially improved this paper. All errors and omissions are our own responsibility.