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For the the paper summarized in the posting below, see

See also previously circulated drafts:


The Harvard Law School Forum on Corporate Governance and Financial Regulation, May 16, 2011 posting


Proxy Advisory Firms and Stock Option Exchanges

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday May 16, 2011 at 9:37 am

Editor’s Note: The following post comes to us from David Larcker, Allan McCall, and Gaizka Ormazabal, all of the Accounting Department at Stanford University.


In our paper, Proxy Advisory Firms and Stock Option Exchanges: The Case of Institutional Shareholder Services, which was recently made publicly available on SSRN, we examine the role of proxy advisors in the specific context of stock option exchanges, where firms replace underwater stock options with new awards of options, restricted stock and/or cash. We restrict our investigation to this specific transaction because it is a relatively simple, one-time transaction where the set of design choices are well defined and can be collected from SEC filings. In addition, the precise criteria used by Institutional Shareholder Services (ISS) in making the voting recommendation are known, and we can observe the degree to which an option exchange follows or deviates from their criteria. Finally, there is considerable variation across the firms in the structure of their exchange programs and the influence of ISS on proxy voting outcomes. This enables us to examine the performance implications of plan design choices and the role of ISS in these transactions.

Our analysis is based on a comprehensive sample of 264 stock option exchanges announced between 2004 and 2009. For each exchange offer, we measure the degree of conformity to ISS’ guidelines by comparing the observed design to the set of restrictions required by ISS in order to receive a favorable voting recommendation. We then assess whether the degree of conformity with ISS voting criteria is related to subsequent firm performance and executive turnover.

Our analysis produces four important results. First, we find that the stock market reaction to the introduction of exchange plans is positive, but decreasing in the extent to which the exchange plan conforms to ISS guidelines. Second, we document that the increase in operating performance associated with introduction of exchange programs is a decreasing function of the degree of conformity with the ISS voting framework. Third, we show that firms with exchange plans that more closely follow ISS requirements experience higher executive turnover than firms with less restrictive plans.

Finally, patterns in insider trading activity during the months prior to the introduction of the exchange programs suggest that insiders‟ expectations about the effect of these programs are consistent with these results. Specifically, insiders are net buyers for firms conducting exchanges with positive performance consequences. These results are consistent with the conclusion that compliance with ISS guidelines on stock option exchanges limits the recontracting benefits of these transactions and are not value increasing for shareholders.

The full paper is available for download here.



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