School of Finance, Capital University of Economics and Business; Research Institute of Economics and Management, Southwestern University of Finance and Economics
Summary:
Mergers and acquisitions are among the largest risky investments that a company will ever undertake. In recent years, the number and scale of mergers and acquisitions in China have been growing relatively quickly. Although previous studies of corporate finance have examined a wide range of determinants of firms' M&A decisions, few have explored the role of executive compensation incentives in the mergers and acquisitions process. At the end of 2005, China's “Administrative Measures on Equity Incentives for Listed Companies (Trial)” was promulgated. Over time, the strength of stock option incentives has increased significantly for listed companies in China. Stock option incentives have gradually become a normal incentive mechanism. How the implementation of a stock option incentive system over a ten-year period has affected the M&A behavior of listed companies in China is still an open question. Do stock option incentives that align managers' interests with those of shareholders induce managers to undertake value-enhancing mergers and acquisitions？ How do stock option incentives influence these M&A decisions？ To answer these questions, our study first empirically examines the impact of stock option incentives on firms' mergers and acquisitions behaviors, and then explores how the characteristics of executives and the nature of property rights affect the relationship between stock option incentives and firms' mergers and acquisitions behaviors. The theoretical explanations for the effect of stock option incentives on firms' M&A behaviors are based on agency theory and risk-taking theory. First, stock option incentives that link the personal wealth of managers to the firm's stock price are an important way to unify the interests of shareholders and managers. In this way, stock option incentives can alleviate the agency problems in the M&A process, and thus have a positive impact on a firm's M&A decision. Second, the sensitivity of stock option value and stock price volatility will enhance the risk preferences of managers. Hence, by increasing risk tolerance, stock option incentives may generate a positive impact on firms' M&A behaviors. Using panel data of Chinese listed firms from the 2006 to 2015 period, we empirically examine the effect of stock option incentives on firms' M&A behaviors. Our results show that executive stock option incentives improve the M&A tendency and M&A scale of listed companies in China. Relieving agency problems and increasing risk-taking are potential channels for these effects. We show that the heterogeneity of managers' specific characteristics moderates the effects of stock option incentives. The positive effect of stock option incentives on M&A is more pronounced for older managers, longer tenure managers, and managers with lower relative compensation. In addition, the impact of stock option incentives is more prominent in non-state-owned enterprises. Finally, our study finds that stock option incentives also enhance the financial performance of mergers and acquisitions. The three contributions of this study are as follows. First, few studies have explored the impact of compensation incentive mechanisms on the M&A behaviors of Chinese firms. Our study reveals how stock option incentives play a role in Chinese firms' M&A activities and therefore provides new empirical evidence for the determinants of firms' M&A decisions. Second, this study enriches and expands the literature on the economic consequences of stock option incentives. The findings stress the positive role of stock option incentives from the perspective of firms' M&A behaviors. Third, this study introduces the heterogeneity of incentive objects and firm characteristics to the framework for investigating the impact of stock option incentives on firms' M&A behaviors, and thus reveals the heterogeneous impact of stock option incentives. In addition, this study has important policy implications. First, our findings stress the positive role of stock option incentives in mobilizing executives and improving corporate governance, which verifies the importance of establishing and improving the option incentive mechanism in China. Second, we find that the effect of stock option incentives varies with managers' specific characteristics, which suggests that to optimize the incentive effect, stock options incentives should be set according to managers' characteristics. Finally, our study finds that the impact of stock option incentives on the M&A behaviors of state-owned enterprises is not obvious, which indicates the importance of improving the incentive mechanisms for state-owned enterprises.
Aggarwal, R. K., and Samwick, A. A. 2006. “Empire-builders and Shirkers: Investment, Firm Performance, and Managerial Incentives”, Journal of Corporate Finance, 12(3):489～515.
[13]
Amihud, Y., and Lev, B. 1981. “Risk Reduction as a Managerial Motive for Conglomerate Mergers”, The Bell Journal of Economics, 12(2):605～617.
[14]
Bantel, K. A., and Jackson, S. E. 1989. “Top Management and Innovations in Banking: Does the Composition of the Top Team Make a Difference？” Strategic Management Journal, 10(1):107～124.
[15]
Barker III, V. L., and Mueller, G. C. 2002. “CEO Characteristics and Firm R&D Spending”, Management Science, 48(6):782～801.
[16]
Bernile, G., Bhagwat, V., and Rau, P. R. 2014. “What Doesn't Kill You Will Only Make You More Risk-loving: Early-life Disasters and CEO Behavior”, The Journal of Finance, 72(1):167～206.
[17]
Bertrand, M., and Mullainathan, S. 2003. “Enjoying the Quiet Life？ Corporate Governance and Managerial Preferences”, Journal of political Economy, 111(5):1043～1075.
[18]
Chen, D., and Zheng, Y. 2014. “CEO Tenure and Risk～Taking”, Global Business and Finance Review, 19(1):1～27.
[19]
Coles, J. L., Daniel, N. D., and Naveen, L. 2006. “Managerial Incentives and Risk-taking”, Journal of Financial Economics, 79(2):431～468.
[20]
Croci, E., and Petmezas, D. 2015. “Do Risk～taking Incentives Induce CEOs to Invest？ Evidence from Acquisitions”, Journal of Corporate Finance, 32:1～23.
[21]
Fang H., John R., and Quan J. 2015. “The Effects of Employee Stock Option Plans on Operation Performance in Chinese Firms”, Journal of Banking and Finance, 54:141～159.
[22]
Gibbons, R., and Murphy, K. J. 1992. “Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence”, Journal of Political Economy, 100(3):468～505.
[23]
Hambrick, D. C., and Mason, P. A. 1984. “Upper Echelons: the Organization as a Reflection of Its Top Managers”, Academy of Management Review, 9(2):193～206.
[24]
Hayes, R. M., Lemmon, M., and Qiu, M. 2012. “Stock Options and Managerial Incentives for Risk Taking: Evidence from FAS 123R.” Journal of Financial Economics, 105(1):174～190.
[25]
Hayward, M. L., and Hambrick, D. C. 1997. “Explaining the Premiums Paid for Large Acquisitions: Evidence of CEO Hubris”, Administrative Science Quarterly:103～127.
[26]
Holmstrom, B., and Weiss, L. 1985. “Managerial Incentives, Investment and Aggregate Implications: Scale Effects”, The Review of Economic Studies, 52(3):403～425.
[27]
Jensen, M. C., and Meckling, W.H. 1976. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics, 3(4):305～360.
[28]
Jensen, M. C., and Murphy, K. J., 1990. “Performance Pay and Top-management Incentives”, Journal of Political Economy, 98(2):225～264.
[29]
Lambert, R. A. 1986. “Executive Effort and Selection of Risky Projects”, The Rand Journal of Economics, 17(1):77～88.
[30]
Lin, C., Officer, M. S., and Shen, B. 2018. “Managerial Risk-taking Incentives and Merger Decisions.” Journal of Financial and Quantitative Analysis, 53(2):643～680.
[31]
Low, A., 2009, “Managerial Risk-taking Behavior and Equity-based Compensation”, Journal of Financial Economics, 92(3): 470~490.
[32]
Malmendier, U., and Tate, G. 2008. “Who Makes Acquisitions？ CEO Overconfidence and the Market's Reaction”, Journal of Financial Economics, 89(1):20～43.
[33]
Parrino, R., Poteshman, A. M., and Weisbach, M. S. 2005. “Measuring Investment Distortions When Risk-averse Managers Decide Whether to Undertake Risky Projects”, Financial Management, 34(1):21～60.
[34]
Smith, C.W., and Stulz, R. M. 1985. “The Determinants of Firms' Hedging Policies”, Journal of Financial and Quantitative Analysis, 20(4):391～405.
