Managerial Power in the Design of Executive Compensation: Evidence from Japan

Stephen P. Ferris, Kenneth Kim, Pattanaporn Kitsabunnarat and Takeshi Nishikawa

A chapter in Issues in Corporate Governance and Finance, 2007, pp 3-26 from Emerald Group Publishing Limited

Abstract: Using a sample of 466 grants of stock options to executives of Japanese firms over the years 1997–2001, this study tests the managerial power theory of compensation design developed by Bebchuk, Fried, and Walker (2002) and Bebchuk and Fried (2004). This theory argues that managers of firms with weak corporate governance will use their “power” to design executive compensation that is “manager-advantageous.” Using our option grants sample, we test to determine if any of the firm's governance mechanisms are able to limit managerial self-dealing with respect to executive stock options. We find that smaller boards and a higher percentage of independent directors are important governance mechanisms for the control of managerial influences in the design of stock-option compensation. An alternative hypothesis, that firms elect to grant advantageously designed options to encourage risk taking by managers, is not supported by our empirical results. Finally, we determine that the market response to the announcements of such grants varies inversely with the extent to which the options are managerially advantageous. Overall, we conclude that managerial power effects are present in the design of executive stock options and that theory of managerial power advanced by Bebchuk et al. holds internationally.

Date: 2007
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Persistent link: https://EconPapers.repec.org/RePEc:eme:afeczz:s1569-3732(07)12001-6

DOI: 10.1016/S1569-3732(07)12001-6

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