The effect of M&As on equity compensation

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The effect of M&As on equity compensation

Name: Vincent Hildering Student number: 11094753 Date: 25-06-2017

Word count: 11.175

Thesis supervisor: M. Schabus

MSc Accountancy & Control, specialization Control Amsterdam Business School

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Statement of Originality

This document is written by student Vincent Hildering who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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1. Introduction

Equity compensation represents a significant increase in CEO’s compensation (Dong, Wang and Xie, 2010). A reason for this widely adopted mechanism is equity compensation aligns managerial behaviour with the maximization of shareholder value by ensuring the goals of the management are to maximize firm’s performance (Jensen & Meckling, 1976). Stock is issued in order to achieve this certain goal. An increasing use of equity compensation, stock ownership and options, should affect investment-decisions by making CEO’s wealth more sensitive to both company’s risk and performance. However, the sensitivity of CEO’s wealth to stock volatility, stock options, may cause riskier investment choices by the CEOs who are seeking to benefit from increasing price volatility (Guay, 1999). I investigate whether firms that engaged in Mergers and Acquisitions (henceforth M&As)1_{are considering the different effects of the CEO’s equity}

compensation in the post-M&A period. My intuition is CEO’s equity compensation in the immediate period following a M&A is crucial in order to stimulate the decisions of the CEO which are related to shareholder value maximizing in the M&A integration process.

This paper examines the effect from M&As on the use of equity compensation. M&A has become increasingly popular, even though its failure rates are estimated between 60% and 80% (Marks and Mirvis, 2001). Since M&A is mostly a strategy to create a long-term firm growth, it requires effort of the management to integrate the firms and to achieve performance (Shrivastava, 1986). The behaviour of the management in the integration process is the key and it is affecting acquisition outcomes. M&A can also be seen as a risky investment, especially if the integration expectations upfront are high and it requires a high synergy realization of the firms by the management (Kode, Ford & Sutherland, 2003). CEOs might be engaged in a risky-M&A because they overestimate their own abilities to successfully complete a highly potential yet risk inducing integration process (Langer, 1975). Studies have shown negative abnormal return within three years after a merger (Agrawal et al., 1992; Moeller et al., 2003). However, the study of Dutta and Jog (2009) emphasized that integration is a slow process and it is possible to create positive long-term performance although failure rates are high.

In this process, compensation contracts should stimulates the CEOs to pursue a maximization of firm’s value in the post-acquisition period to facilitate an integration process which result in positive long-term performance. Firstly, I hypothesize that in the period subsequent to a M&A, the acquiring firms should increase CEO’s stock ownership. While at the same time firms also have to manage the amount of risk-taking behaviour in the integration

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process. Secondly, I hypothesize that in the period subsequent to risky-M&As, firms issue less options as compared to the period following not risky-M&As.

This study is written because the literature issues of organizational fit and post-merger integration have received considerably less attention (Jemison and Sitkin, 1986). There are extensive research which investigates CEO’s compensation and their risk-inducing effects in the pre-M&A period (Eisenmann, 2002). However, there is less research which examines the effect of M&As on equity compensation in the post-M&A period. Prior research has observed the increase in the director’s compensation packages after the completion of M&A (Certo, Dalton, Dalton & Lester, 2008). In the contrary the high failure rates of M&A is conflicting with an increase in the compensation for CEO. Spraggon and Bodolica (2011) built on this study and undertook a broader context of M&A and the effect on equity compensation. They examined the extent to which a set of acquisitions activities affecting board of director’s decisions to restructure incentive design for the executives. They investigated solely on risky-M&A of a Canadian datasample.

The observation of Balkin and Meija (1987) showed the strategic implementations of an organization are reflected by the incentives used. Therefore, this study aims to determine whether a long-term strategic decision of conducting M&A is actively managed by a significant change in equity compensation. Furthermore, Gray and Cannella (1997) observed risk which related to the strategic implication of the organization is considered in the CEO’s compensation to align with the interest of managers and shareholders. The view that equity compensation as reflected by stocks and stock options do not have the same congruent incentive is broadly understood in the literature nowadays (Devers, Mcnama, Wiseman & Arrfelt, 2008). Consequently, this study will give first a fundamental insight whether the different risk preference exposed from the M&As investigated will have their effect in structuring the equity mix between stockownership and options. This insight will contribute to the discussion regarding seeing stockownership and options not only as different components, but also an indication that equity compensation could support goal alignment for maximization of shareholder value and avoid risk-aversion, yet also ambiguously could increase risk-taking behaviour and possibly harm shareholder value. Due to the high failure rates of M&A, evidences confirmed CEOs are hold responsible for M&A’s failure and subsequently poor performance (Cho, Arthurs, Townsend, Miller & Barden, 2016). That suggest firms have an active tool to avoid negative outcomes within the integration process.

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2. Literature Review

Agency Theory

In an organization not all decisions can be made by the owner or the principal due to limited time and skills. Therefore the principal usually allocates decision-making process to the agents who work on behalf of them. The welfare of the principal became affected by the decisions of the agents (Jensen & Meckling, 1976). The first agency problem arise is a difference between the desired goals of the principal and the agent which result in conflicts (Eisenhardt, 1989). Even though both parties can be considered as utilize maximizers, agents will not always act in the best interest of the principal. Agents can prefer self-serving behaviour during decision-making process to increase their own personal wealth, also known as perquisites consumption (Ang, Cole & Wuh Lin, 2000). The second agency problem is when a principal cannot verify whether the agent has behaved appropriately. Agents and principals do not share the same risk level and therefore might pursue different actions in which will match their risk preferences.

To tighter align interests between principal and agent, there is extensive amount of instruments and theories described in the literature which can resolve the principal-agency problem. Governance mechanism commonly exists of two features that limit the agent’s self-serving behaviour and risk-sharing (Eisenhardt, 1989; Dharwadkar, George, & Brandes, 2000). All of these features will result in agency cost. These costs are the consequence of putting mechanisms in place to limit the aberrant activities of agents (Jensen & Meckling, 1976). One feature is using information systems to monitor the behaviour of agents. This is the most efficient tool in pursuing the right actions to achieve the principal’s goals (Nyberg, Fulmer, Gerhart & Carpenter, 2010; Jensen & Meckling, 1976). However, the increase of agency costs from monitoring agent’s behaviour could be high. Therefore there is a preference for another representative of governance mechanism (Eisenhardt, 1989). Based on the outcomes of the agent’s behaviour, an agent is paid incentives in exchange for their commitment to the future behaviour that is desired (Rousseau and McLean Parks, 1993). Another feature is outcome based contracts. These contracts generally contain incentive provisions designed to encourage agents in order to maximize firm value. These provisions aligns executive compensation from the agents with firm performance (Dechow and Sloan, 1991) The expectation that the agent’s financial compensation will be strongly contingent on the principal’s outcomes should motivate the agent to direct their attention, preferences and efforts toward those actions which will benefit the principal (Nyberg et al., 2010). Inclusively, outcome-based contracts transfer the risk to agents. This risk can be conceived as positive or negative in light of shareholder maximization value.

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Agents are risk-averse because in contrast to principals who can diversify their investments, agents are unable to diversify their employment risk (Dharwadkar et al, 2000). This could result in forego risky positive investments. The principals are using outcome-based contracts with intention that the risk-averse agents will become encouraged to take more risks. However, they might also become less profitable by conducting excessive risk-taking beyond the optimal level (Dong et al., 2010). In light of this research, the consequences of outcome-based contracts have made it clear that there is a balance between risk-sharing and excessive risk-taking.

Horizon Problem and Compensation

Outcome-based contracts can emphasize different dimensions of firm performance. Agents can be rewarded based on accounting-earnings-based performance through an annual bonus plan or on stock-price’s performance through an incentive stock-plan or stock-option plan. Rewarding the agents or executives with accounting-earnings-based incentives is a common concept for incentivize employees. A form of salary and bonus compensation is a type of pay package. The payoff of these packages only reflects the effort done until the payment date. These pay packages gives no additional incentive to stimulate the desired behaviour from the executives because the payment is fixed and it is independent from the firm’s subsequent performance (Lewellen, Loderer & Martin, 1987).

The criticism lies in accounting-earnings-based incentives which will encourage managers to focus on short-term performance (Dechow and Sloan, 1991). This supports the appearance of myopic behaviour also known as the horizon problem. Managers with short horizon prefer projects with positive current earnings instead of higher future earnings. Consequence of myopic behaviour is the avoidance of the higher net-present-value projects because they appear to be outside the reach of an agent’s employment time (Antia, Pantzalis & Park, 2010). The short-sighted effort which arise from accounting-earnings-based incentives are contradicting with the maximization of firm performance representing the wealth creation for the shareholder (Dikolli, 2000). The financial crisis in 2008-2009 has led to a widespread recognition that pay arrangements which reward executives for short-term results can also produce incentives to encourage them in taking more excessive risks since the horizon problem is facilitated by the management's use of discretionary accruals (Dechow and Sloan, 1995; Lucian, Bebchuk and Fried, 2010).

Lewellen, Loderer & Martin (1987) discussed that executives need to be given an explicit claim to future cash flow in order to encourage proper attention into decisions which will affecting themselves favourably. Management scholars advocate that manager’s compensation

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should be based on conveying equity interest in the firm (Hrebiniak & Joyce, 1983; Lambert and Lacker, 1987). Compensation based on stocks or stock options should link managerial effort to long-term firm performance. This aligns the interest of the shareholders as the future wealth creation with the interest of agents. Equity-based compensation result in a strengthen market’s ability to predict future earnings (Choi and Kim, 2016). This statement means the agents is not using their private information to maximize their own personal wealth by creating a temporarily stock price increase, but instead showing the desired actions which inform the market to anticipate on future earnings of the firm by increasing the current stock price. Equity compensation will be further addressed in the next paragraph.

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Restricted stock and stock options

Equity-incentives are mostly consists of granting a portion of restricted stock or stock options. Restricted stock grants are recorded on the grant date under owner’s equity as deferred compensation. They endow executives with a fixed quantity of shares which have restriction on resale or transfer. The awarding is forfeit if an executive leaves before the lapsing of the stock (Bryan, Hwang, & Lilien, 2000). Their value is directly derived from the company’s stock price. Another component of equity-incentives is stock options. An option-holder will exercise the option according to a strategy with the aim to maximize its value (Carpenter, 1998). The value of an option grant is measured as the difference between the strike price and the company’s stock price. As a simplistic and practical manner, almost all stock options are awarded at-the-money with a 10-year duration and commonly vesting over a 3 to 5-year period and gain value when the stock price increase above the strike price (Bryan et al., 2000).

An important difference between the restricted stock and option lies in the respective payoff functions and related risk-inducing effect. The increase in value of restricted stock, which is determined by its payoff function, is linear. The linearity makes it uncomplicated to calculate the incentive effect because every 1% increase in the stock price will produce a 1% increase in the stock value. Hence, stockholdings expose managers to both downside and upside stock price movements (Miller & Leiblein, 1996). For options, the payoff function is more complex because the percentage increase in the value of an option is less than the percentage in the stock price (Guay, 1999). There are many factors in the option contract which affects the value of the option. In many cases with the usage of the Black and Scholes model, the change in value of an option by a change in stock price can be calculated straightforward. Nevertheless, the theory assures options provide the potential for unlimited gains while limiting downside risk (Miller & Leiblein, 1996). Given in the event that the stock price is below the option price, no executive would exercise the options. Thus, both stockholdings and options will result in executive’s benefits from rising stock price. However, only stockholdings of executives will suffer from immediate wealth reduction (Sanders, 2001). The slope of the relationship between manager’s equity-value and stock price called delta. An increasing delta makes manager’s holding in the firm more sensitive to the increase of the stock price (Low, 2009). The executive’s overall delta is thus equal to the delta from the stock ownership plus the delta from the option ownership (Dong et al., 2010).

The study of Guay (1999) highlights an underlying relationship explaining the risk-inducing effect, in which the effect is only exposed from options. This relationship is called vega and it defines the change in the value of options for a 1% change in the underlying stock-return

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volatility. In another terms, it explains the sensitivity of manager’s equity value to stock return volatility (Low, 2009).

The relationship between delta and vega in terms of risk is an increasing delta make managers more risk-averse. As seen before, agents are unable to diversify their portfolio. Tie executive’s wealth to the value of the firm would include that the agents bear the potentially losses of risky projects which will reduces the executive utility (Bryan et al., 2000). This makes agents more risk-averse to undertake risky projects. The expected wealth for managers is an increasing function of a firm-risk. As firm risk characterized by the volatility of an investment in assets increases, the range of potential return which can be positive or negative also increases (Sharpe, 1970). Since the expected payoff of an option is increasing when firm-risk increase, while at the same time executives are secured from downside risk, grant options will induce risk-averse managers to participate in positive net value projects that are sufficient risky (Armstrong & Vashishtha, 2012). Many scholars have described this view, however the line between incentives to induce risk and incentives that create excessive risk which exacerbates risk aversion, remain controversial (Devers et al., 2008). By means of this, options can be contrary with maximization of shareholder value. Dong et al. (2010) evidenced that managers engage in excessive risk-taking as an unintended consequence of giving large options, which is not align with the interest of the shareholders.

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Merger and Acquisition

Within the context of globalization and competitiveness, companies try to improve their positions with business strategies to improve organizational performance. M&A as a chosen business strategy continue to play an important role in shaping business activities worldwide. Horizontal M&A2_{has especially become increasingly popular (Capron, 1999; Vazirani, 2012).}

Mergers are a circumstance in which the assets and liabilities of a company are vested in another company. It is the combination of two separate companies into one single company. These two companies come together to create a new identity with shared objectives and strategies. An acquisition is a corporate action in which a company buys most or all shares from the target companies in order to take control over the operations. Acquisitions are often part of the acquirer’s growth strategy (Vazirani, 2015). The integration of these processes is defined by Larsson and Finkelstein (1999) as the degree of interaction and coordination of the two firms involved in a merger or acquisition.

The quest for growth is the primary motivation to undertake M&As. When there is a constraint to internally grow, evidence provide that acquire new resources (M&A) are the only way to create growth (Homburg & Bucerius, 2005; Steger & Kummer, 2007). This growth mainly occurs in the synergy effect described by the resource-based theory. The resource-based theory holds that firms have superior performance by specific resources owned. These resources are assets, capabilities, information, knowledges or other instruments in which enable firms to implements strategies to improve efficiency and effectiveness.

The main belief of a merger and acquisition is the combined companies, which means their assets will have greater value than the two companies separately. A synergy effect is the stated objective (Marks & Mirvis, 1992). In the study of Capron (1999) it is described how value is created by the cost-saving synergy. M&A is an opportunity to achieve cost-saving through the exploitation of economic of scale and scope. Economic of scales result in cost-saving when the sharing activities of the merging firms achieve an increase in scale of activities which realize a cost-saving per unit. An example is spreading the firm’s fixed costs of resources over a higher production volume. Sharing activities can also result in cost-saving based on learning curve economy. In both cases the less efficient assets are divested.

Additionally, M&A creates value from the ability to enhance revenues by accessing complementary resources. The revenue-based synergy is caused by an increasing market coverage in which allows the merged firm to sell existing products to a wider body of consumers

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and to bundle product’s abilities for a greater costumer’s perception of existing products. Innovation in using shared capabilities of technology, patents and know-how can lead to higher revenues. The revenue-based synergies (market coverage and innovation) through acquisitions are usually achieved from resource deployment of both acquiring and target firm.

M&A failure

Despite the increase in M&A a business strategy, there are many M&As which fail to create shareholder value. There is significant evidence that M&A are unsuccessful. Ratings are typically between 60 and 80 % (Marks and Mirvis, 2001). In the academic literature, there is a wide extent of reasons why M&A are undertaken and subsequently failed. Rational explanations for the failure are represented by the shareholder value-maximizing theory. Irrational explanations are represented by the managerial theory and focus on individuals, particularly on top managers who engage in ‘empire building’ which is detriment for shareholder value (Steger & Kummer, 2007; Capron, 1999). Linking the main potential causes of the failures into rational explanations lack of integration and leadership in the integration process are observed. The academic field for irrational explanations is mainly dominated by the overconfident and overoptimistic CEOs (Haspeslagh and Jemison, 1991; Hayward and Hambrick, 1997; Haunschild, 1993; Roll, 1986). Unlike traditional empire-builders, these overconfident CEOs believe that they are acting in the interest of shareholders and are willing to personally invest in their companies (Malmendier & Tate, 2008). Both explanations of failure (lack of integration and leadership, and overconfident CEOs) will be explained below.

Kode et al. (2003) described lack of integration from the target and acquiring firms in M&A is the reason of failure due to potential for synergy creation is remains unrealized. The study of Seo and Hill (2005) focused on six theoretical frameworks which explain the problems in the human integration process of M&A. These theories identify the source of problems during the M&A process and the psychological behavioural effects on the employees. During the acquisition process, not only employees feel anxiety about the possibility of job loss or changes in their current position, but also facing the uncertainty regarding job characteristics which will influence the quality of their work. Clashes of cultures from the two different organizations and organizational justice on how employees perceive themselves being treated fairly are all consequences in which need to be reflect on. Human resources are one of the most valuable instruments in the company. Understanding the unique features and critical steps in managing human integration process is the key to avoid negative outcomes (Gomes, Angwin, Weber, & Yedidia, 2013). Furthermore the research from Haspeslagh and Jemison (1991) specified the

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growing recognition that all value creation takes place after the acquisition. They indicated the lack of leadership or strategic guidance in the post-integration process. Different executives in a parent company often have different stakes in particular strategies and see different opportunities, which can result in conflicts from the top organization when the key executives cannot agree on general direction (Marks and Mirvis, 1992).

Managerial overconfidence refers to the psychological bias of how people overestimate the probability of their success and underestimate the probability of their failure (Langer, 1975). An overconfident CEO leads into excessively good synergy expectations. Before M&A is approved, there is a broad investigation of possible success from the firm’s entire board of directors, even though it is widely recognized that the CEO is the one who usually initiates the M&A and oversees its progress (Soegiharto, 2010). The two explained theoretical views come together in the integration process of M&A. It indicates the central role of the CEO and confirms their decisions are crucial in the M&A’s integration process (Soegiharto, 2010). However, the reasons to undertake M&A are mixed and it causes different explanations for failure (Steger & Kummer, 2007).

This study argues that the reasons to undertake M&A comes from the resource-based theory where there is a need to integrate the human and the firm’s productive resources, together with the theoretical explanation of managerial overconfidence with an individual persistence. In both theories the managerial involvement is crucial in the integration process. The resource-based theory is used to develop hypothesis 1. Managerial overconfidence is used to develop hypothesis 2.

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Hypothesis

As discussed in the literature review in this study, M&A is a transition which brings a lot of risk to potential failure. In the study of King, Dalton, Daily and Covin (2004) it is concluded that the stock values for both acquiring and target firms generally increase significantly on the day of the acquisition announcement. This suggests shareholders expect synergy creation on the long-run from M&A. Despite this expectation, after the acquiring process accounting performance such as return-on-assets or return-on-sales frequently shows no positive gain (Vazirani, 2012).

Nevertheless, acquisition is not necessarily leads to value destruction. The study of Dutta and Jog (2009) observed acquisitions on the long-run in the Canadian market which is not showing significant negative abnormal returns. From this example it can be derived that M&A is not definitely leading into poor performance, but it is an opportunity to maximize shareholder value. However, under the right conditions and if it is managed well, shareholder value can be achieved. Creating growth is one of the main objectives pursued by M&A and it requires strategic control. Reward systems can direct effort from the executives towards the strategy implemented (Sculer and MacMillan, 1984). Therefore, incentive compensation reflects the strategy intentions of a firm (Balkin and Meija, 1987).

Accounting-earnings-based incentives stimulate managers to focus on short-sighted effort in order to increase short-term performance. This is contradicting with the maximization of firm performance representing the wealth creation for shareholder (Dechow and Sloan, 1991; Dikolli, 2000). As described previously, M&A requires an integration process in which managerial behaviour is the key for a successful M&A. In a survey conducted from 124 executives and managers in different industries, 67 percent emphasize that it took the company one until five years to complete the integration process (Galpin, 2008). Hence, managers need to understand the unique features and complex relationships in the integration process to create cost and revenue-based synergy advantages (Gomes et al., 2013; Seo et al., 2005). Consequently, firms should stimulate CEO to take decisions which will contribute to performance on the long run.

Equity compensation incentivizes CEOs to focus on long-term performance instead of short-term one (Lucian, et al., 2010). Decisions that contribute to the future value creation will be absorbed by the stock price. It motivates an executive to direct their attention, preferences and efforts toward those actions which benefit the principal (Nyberg et al., 2010). The incentive effect of an increasing delta from stockholdings makes manager’s wealth more sensitive to stock price returns. CEOs who receive restricted stock bear the potential loss in their wealth when firm performance decrease. Moreover, the study of Schmidt and Fowler (1990) have observed

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executives who have been engaged in major tender offers or acquisition activities will receive significant increase in their compensation3_{. An increasing delta and the study of Schmidt and}

Fowler indicate granting stocks could stimulate CEOs to take decisions in which create long-term performance in the post-M&A period. This is examined with the following hypothesis:

H1: There is a positive relation between M&As and future stock issuance

This research focuses also on the integration process of risky-M&As. The study of Hoberg and Phillip (2017) observed risky mergers with high integration risk ex ante increase the likelihood of post-integration difficulties. High integration risk is defined as the possibility where it will be value loss from M&A-activities. Consistent with high integration risk are higher expenses, exploitation of resources and asset divestiture. However, these issues give potential for high synergy in the integration process.

Risky-M&As can be undertaken by overconfident managers. These managers invest in risky-M&As because they have a highly positive perception on the post-M&A success and underestimate the probability of failure (Langer, 1975). An important implication of this study is CEO’s positive perception on post-acquisition success will result in early speed of actions (Angwin, 2004). The time to complete the integration process is typically speeded up by managers (Schweiger and Walsh, 1990; Angwin, 2004). The overconfidence managerial behaviour is a stimulating force of speed which can reduce considerations of integration issues (Hitt, Harrison & Ireland, 1998). The literature grounded in the resource-based theory is ambiguous regarding integration speed. Speed up the integration process will reduce the uncertainties for customers in terms of pricing, policy, sales and customers turnover, which will positively influence marketing performance (Homburg and Bucerius, 2006). On the contrary, slow integration allows more careful consideration in integration issues and building trust between employees (Bijlsema-Frankema, 2004). Even though overconfident managers can act in the best interest of shareholders and perceive risky-M&As as opportunities to create value, the integration process is still need to be carefully implemented. Otherwise overconfidence managerial behaviour can result in risk-taking actions of the CEOs.

Another reason why CEOs consider risky M&As is due to the increased volatility of the stock return. Risky projects are expected to increase payoff of an option (Armstrong &

3_{Schmidt and Fowler (1990) investigate the effect of acquisition on the level of executive compensation. The}

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Vashishtha, 2012). Moreover, integration speed can be pursued in M&A where pure managerial self-interest causes value-destruction instead of value-creation according to the objective laid out by the same management to justify their acquisition strategies (Moeller et al., 2005; Jiang et al., 2011). M&As represents major examples of managers who conceive them as an opportunity for achieving higher level of payoff (Spraggon and Bodolica, 2011). CEOs may benefit from their responsibilities to undertake M&A for their own potential wealth, although it is possible that executives make decisions which jointly satisfy their own interest as well as those of shareholders (Certo, et al., 2008).

Due to the fact that motivations for M&A are mixed, this feed the assumption that M&A are undertaken to increase shareholder value, even though overconfident managers usually attempt to speed up the process which will induce risk-taking behaviour. Especially in a risky-M&A where the integration risk is high and synergy achievement is difficult, there is a trade-off between realizing lower short-term synergy and the opportunity for higher but long-term synergy (Garzella & Fiorentio, 2014). Since options makes CEO’s wealth more sensitive to stock return volatility, CEOs can be induced to speed up the integration process. Therefore, options in incentive contracts are decreased to discourage the risk-taking behaviour of speeding up the integration process which causes value destructing actions. This is examined with the following hypothesis:

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3. Research methodology

Data sample selection

The aim of this study is to examine the effect of M&As on CEO’s equity compensation. Therefore I collected data from firms which have undertaken M&A. The data source used for M&A is Thomson One. It is important to determine on which parameters the data sample is based. These parameters are criteria to find a proper data sample for M&A.

The study is focused on acquiring firms which are involved in M&A. I selected US listed firms. It is important to identify acquiring firms which have the same constraints in terms of legislations. This means the requirements of the Sarbanes-Oxley Act make certain that all US firm’s compensation disclosures are based on the same framework (Verbaas, 2015). An additional advantage of using US firms is they have historically an extensive amount of research. This makes the implication and fundamentals of other studies applicable on this research. Furthermore, the US market contains a diverse set of firms with different types of sizes, industries and corporate characteristics. Secondly, I identified exclusively US public firms. Due to the limited availability of the data, I restricted to use only public companies. The time period chosen is 2005 until 2013 for the M&As. Since not all variables I wanted to select were available for each M&A in Thomson One, therefore to select an appropriate amount of M&As, it was only possible with a long time period.

In the sample, I included only acquiring firms which completed the acquisition process because this study focuses fully on the equity compensation in the post-M&A period. Lastly, I limited the sample by excluding firms in the financial or utility industries. These firms have unique and excessive regulatory concerns, which make them unsuitable to use in the sample. Typically they are excluded from data studies. This means I did not select firms with SIC code 6000-6999 and 4900-4999 for the sample (Hanlon & Hoopes, 2014).

To collect data for CEO’s equity compensation I used the database ExecuComp. This database gives the required information regarding annual data of the firm executive’s compensation in S&P 500, S&P 400 mid-cap and S&P600 small-cap (Cadman, Klasa & Matsunaga, 2010). From ExecuComp I collected data regarding the value of CEO’s stock grants and option grants (the fair value on grant date) and all other compensation granted during the fiscal year (Bryan et al., 2000). ExecuComp covers all the years from the Thomson One database. Within ExecuComp, the data of directors can be retrieved on individual level including information about their positions, age and the CEO within the current fiscal year. This information allows me to determine the CEO’s total compensation per acquiring firm. Furthermore, I used the database

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19 Compustat and Thomson One to retrieve data for the construction of control variables. In the paragraph ‘control variable’ these constructions are explained further. I merged the different databases based on a unique identifier for each acquiring firm. After excluded the observations for which the appropriate values were not available, I am left with 236 M&As undertaken by 236 different firms. I deleted firms that already undertook M&A in the prior 5 years. This action avoided prior M&A’s influence on equity compensation level of the 236 selected M&As. From this 236 M&A data sample not all of them are risky, I then selected the risky-M&As only which left in the amount of 136. In the paragraph ‘Independent variable’ explained how these risky-M&As are selected.

Hypothesis 1 tests the relationship between M&As and the change in stock grants. I used the post-M&A firm-years to measure the change in stock grants. Because it can take time before M&A have impact on the CEO’s compensation (Guest, 2009), the change in stock grants is measured over a three-year period since the completion-year of the M&A (Spraggon and Bodolica, 2011). For equity compensation I use therefore the time period 2005 until 2016. The completion of the M&As in year t, and the following post-M&A years t+1, t+2 and t+3 need to be compared with a reference point. Similar as Core and Lacker (2002) I identified also a control group. This control group consists of firms which does not undertaken M&A. In total there are 265 non-M&A-firms included in the control group. I compared the change in stock grants of M&A-firms with the change of stock grants of non-M&A-firms. I collected data about equity compensation for the non-firms over the same time period (2005-2016) as for the M&A-firms. Additionally, I applied the same criteria for the non-M&A-firms to select a data sample from Execucomp: US firms, Public firms and excluded firms with SIC Codes 6000-6999 and 4900-4999. A large time period is chosen for the data sample. However, the use of a control group makes it possible to conduct a valid statistical analysis since the year specific characteristics are both applicable on the M&A-firms and non-M&A-firms.

The same data sample selection and measurement-period is used for hypothesis 2 as explained above. However, hypothesis 2 tests the relationship between risky-M&As and the change in option grants. To test for a significant relationship I compared the change of option grants of risky-M&A-firms with the change of option grants of non-risky-M&A-firms. Non-risky-M&A-firms is defined as firms who are engaged in M&A but face no high integration risk. The non-risky-M&A-firms are selected by subtracting the 136 risky-M&As from the 236 M&As which are left in the amount of 100.

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Dependent variable

The dependent variable in this study is equity compensation. More precisely I used stock grants for hypothesis 1 and options grants for hypothesis 2. First of all, I measured the proportion of stock grants and option grants of total CEO’s compensation (Mehran, 1995; Spraggon and Bodolica, 2011). Subsequently, I measured the change in the proportion of stock grants (∆stock grants) and the proportion of option grants (∆option grants) between the completion-year t, and the post-M&A years t+1, t+2 and t+3. The proportion of the stock and option grants is used, rather than the dollar value for the reason that board of directors have influence on the amount of stocks and options granted and in a less extent to the stock price to which shares and option values are connected (Shleifer and Vishny, 1977). The proportion of equity compensation reflects the importance as an incentive effect. As an example, when all compensation components increased, the effect of an increase in option grants is less than an individual increase of option grants.

Independent variable

The independent variables in this study are M&As and risky-M&As. Regarding hypothesis 1, the indicator variable M&As takes the value of 1 for firms engaged in merger or acquisition. For firms which are not engaged in a merger or acquisition the variable is 0. Regarding hypothesis 2, the indicator variable M&As takes the value of 1 for acquiring firms engaged in a risky-merger or acquisition. For M&A-firms not engaged in a risky-risky-merger or acquisition the variable is 0.

Next I explained how I subtract risky-M&As from the initial 236 data sample. The study of Antoniou, Arbour & Zhao (2008) concluded the merger premium may well be a proxy for synergies between the acquiring and the target firm. A high premium paid should indicate high potential synergy realization. As evidenced by Larsson and Finkelstein (1991) who investigated synergy realization in merger and acquisitions, there is a positive relationship between synergy realization and the degree of integration difficulties. Sirower (1997) argues a premium exceeds by 25 percent leads into significant risk. Therefore a high premium paid requires more complex integration difficulties. As underlined in the study of Roll (1986), overconfidence managers engage in M&A with an overly optimistic opinion in their ability to create value. Additionally, this leads to managers who pay high premiums for their targets. Based on these two arguments, risky-M&As are measures by a high premium-paid as similar to the research of Spraggon and Bodolica (2011). In my study, a premium of 25 percent is used as a cut-off. The premium paid for an acquisition is calculated by computing the difference between the purchase price for the

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firm’s stock and the target price for the firm’s stock four weeks (one week, one day) prior to the announcement date divided by the target’s stock price four weeks prior to the announcement date (Datta, Iskandar-Datta, & Raman, 2001).

Control variable

The control variables selected in this study have shown to have some effect on equity compensation. Solely measure the effect of M&A on equity compensation means to control other influences. The first control variable used is firm size. As firm size increase, it may become more difficult to monitor agent’s actions (Smith and Watts, 1992). To control, large firms might more likely to use incentive compensation plans and subsequently issue more stocks and stock options. I used the acquiring firm’s book value of total assets at the beginning of the year to control firm size (Size). Duality refers to a CEO who is at the same time chairman of the board of directors. In this situation, a CEO has the responsibility for both making decisions and monitoring those decisions. The ability to objectively monitor the CEO might be impaired and the potential for agency conflicts increased, resulting in greater need for incentive compensation (Ryan & Wiggins, 2001). Brickley, Coles, and Jarrell (1997) found that dual CEOs have significant greater portions of stocks than CEOs who are not board chairs. I used an indicator variable to control CEO/Chairman duality (Dualdummy) and equals 1 when the position of CEO and chairman is combined and 0 if otherwise. Furthermore, I controlled the CEO’s age. The horizon problem is more likely to exist for the oldest and the youngest CEOs. Dechow and Sloan’s study (1991) is grounded on the assumption that older CEOs have the incentive to choose projects that pay-off before they retire. Younger CEOs has more eager to prove them and choose projects with short-term performance (Hirshleifer, 1993). I included the variable age (Age) in the regression model to diminish the effect of younger and older CEO’s higher equity compensation. Moreover, I controlled growth firms. Monitoring may become difficult when a firm has significant growth opportunities (Smith & Watts, 1992). Growth firms may induce more information asymmetries which make manager’s investment choices more difficult to evaluate. This will induce stronger incentives and it can be provided with stocks and options. Growth firms are commonly derived by their Market-to-Book-value (Mehran & Tracy, 2001). I used market value divided by the firm’s book value of total assets as a proxy for growth firms (Growth). Finally, the ratio of operating income to sales is a proxy of the firm’s free cash flows (FreeCashFlows). The measurement I used for a firm’s FreeCashFlows is Earnings Before Interest and Tax divided by the Net Sales. This control variable is used in Himmelberg (1999). The higher the level of free cash flow means the higher the desired level of managerial ownership.

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Empirical model

The empirical analysis is performed by running an Ordinary Least Squares (OLS) regression. Additionally, the OLS regressions are performed with fixed effects. When including year-fixed effects, the model control for things that cannot be measured. For example, economic shocks within years influence compensation yet it is not controlled in the model.

The following model 1 is used for hypothesis 1 which tests the relationship between M&As and the change in stock grants (∆Stock grants).

Model1:

∆Stock grants= α₀ + β1 *M&As + β2 *Size + β3 *Dualdummy + β4 * Age + β5 * Growth + β6 * FreeCashFlows + ε

Model 2 is used for hypothesis 2 which test the relationship between risky-M&As and the change in the option grants (∆Option grants).

Model2:

∆Option grants= α₀ + β1 * Risky-M&As + β2 * Size + β3 * Dualdummy + β4 * Age + β5 * Growth + β6 * FreeCashFlows + ε

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4. Results and empirical findings

Descriptive Statistics

After the data collection and construction of the important variables, each variable is winsorized on the 1st_{and 99}th_{percentile. Winsorizing decreases the influence of kurtosis which indicate}

extreme deviations accounts for most of the variance, and skewness which means the mass of the observations is concentrated in the left or the right and relative few high values are included in the sample (Zhu, Boyaci & Ray, 2011). Table 1 provides the distribution and descriptive statistics of 236 M&As and 136 risky-M&As by U.S. public firms in the period 2005 until 2013. Panel A of table 1 presents the distribution of M&As by their year of completion. On average a completion-year account for 11% in this data sample. Only the completion-year 2007 accounts for 16% of the total M&As. Therefore panel A reports an equally distributed sample by year. Furthermore panel B of table 1 presents the distribution of M&As. Similar as panel A, risky-M&As are relative equally divided over the different sample-years compare to the mean of 11%. Panel C of table 1 provides the distribution of the M&As by their industrial SIC code. The data sample contains high diversity of industrial firms. Still, there is some concentration on the service industry. As explained before, the table excluded firms in the financial or utility industries (SIC

Codes 6000-6999 and 4900-4999).

Panel A: yearly distribution of M&As

M&A completion-year N % of total

2005 24 10.2% 2006 25 10.6% 2007 38 16.1% 2008 33 14.0% 2009 23 9.7% 2010 29 12.3% 2011 16 6.8% 2012 30 12.7% 2013 18 7.6% Average: 11.1%

This table presents the distribution of the data sample selection for M&As and

M&As in the period 2005 until 2013. For M&A-firms N= 236. For

risky-M&A-firms N=136.

Total: 236

Distribution of independent variable Table 1

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Panel B: yearly distribution of risky-M&As

M&A completion-year N % of total

2005 11 8.1% 2006 12 8.8% 2007 17 12.5% 2008 19 14.0% 2009 18 13.2% 2010 22 16.2% 2011 9 6.6% 2012 17 12.5% 2013 11 8.1% Average: 11.1% Total: 136

Panel C: distribution of M&As by Industry Classification

SIC code Industry n % of total

0100-0999 Agriculture, Forestry and Fishing 16 6.8%

1000-1799 Mining & Construction 20 8.5%

2000-2900 Food, Paper, Chemical Products and Petroleum Refining 32 13.6%

3000-3999 Manufacturing Industries 23 9.7%

4000-4899 Transportation & Communications 31 13.1%

5000-5199 Wholesale Trade 5 2.1%

5200-5999 Retail Trade 25 10.6%

7000-8999 Services 65 27.5%

9100-9729 Public Administration 19 8.1%

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Table 2 provides the descriptive statistics for the independent, dependent and control variables used in the empirical models 1 and 2. The mean (0.471) of the indicator variable M&As is close to 50% since 236 M&A-firms and 265 non-M&A-firms are included in the data sample of hypothesis 1. The indicator variable risky-M&As used for hypothesis 2 shows a mean of 0.570, this indicates more risky-M&A-firms are used in the data sample than non-risky-M&A-firms.

On average the change in stock grants (∆Stock grants) from the completion-year of the M&As until year t+3 show a slight increasing trend (0,011). For risky-M&As the change in option grants (∆Option grants) show a decreasing trend (-0,109). However, the descriptive statistics of the change in stock and option grants are provided for both the M&A-firms and the control firms. Therefore, these numbers give no information to further analyse the trend in the stock and option grants regarding the formulated hypothesis.

The first control variable Size is the logarithm of the firm’s book value of total assets. Furthermore, the logarithms are calculated for the variables Growth and FreeCashFlows. Before the logarithms were taken for the variables Size, Growth and FreeCashFlows, the distribution was abnormal. After the logarithm has been taken, the median and percentiles showed to be more normal distributed. The mean and the median for the control variable Dualdummy show that most CEOs in this data sample have only the position of Chief Executive Officer. The mean as well as the median of the control variable Age show that most CEOs have the age of 55.

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Analysing the distribution of stock and option grants is helpful in understanding the changes in equity compensation during the post-M&A years. Table 3 provides summary statistics for the absolute values of stock and option grants and the proportion of stock (Stock%) and option grants (Option%) in the total CEO compensation. The change in equity compensation is analyzed for the post-M&A period including the completion-year. Furthermore, table 3 provides a mean comparison test to analyze if the change in equity compensation between the years t and t+3 is significant.

Table 3 shows the mean of the total compensation change from 5.01 million dollars in year t to 6.05 million dollars in year t+3. A comparison of the means of total CEO compensation between the completion-year t and year t+3 result in a significant change (p=0,019). Noticing that stock and option grants account for the largest amount of the total CEO compensation for all the 4 years, this could signalize an underlying trend in the changes in stock and option grants. The proportion of stock grants (Stock%) steadily increase since the completion-year t until year t+3 from 30% to 41%. Both the stock grants in dollars and as a proportion of total

N Mean St.dev. 10th pctl. 25th pctl. Medain 75th pctl. 90pctl.

M&As 501 0.471 0.499 0.000 0.000 0.000 1.000 1.000 Risky-M&As 236 0.570 0.495 0.000 0.000 1.000 1.000 1.000 ∆Stock grants 901 0.011 0.646 -0.804 -0.244 -0.004 0.133 0.561 ∆Option grants 716 -0.109 0.638 -1.000 -0.456 -0.053 0.111 0.476 Size 2004 2.096 3.072 0.000 0.000 0.000 4.935 6.996 Dualdummy 2004 0.367 0.482 0.000 0.000 0.000 1.000 1.000 Age 2004 55.205 7.652 46 50 55 60 64 Growth 2004 0.170 0.502 0.000 0.000 0.000 0.120 0.814 FreeCashFlows 2004 0.669 1.219 0.010 0.350 0.600 1.321 1.910

This table presents the descriptive statistics for the indicator variables M&As and the

risky-M&As and the dependent variables ∆Stock grants and ∆Option grants .

Desciptive statistics independent, dependent and control variables

For the indicator variabe M&As the observations used are: M&A-firms N=236 & non-M&A-firms N=265. For the indicator variable risky-M&As the observationss used are: risky-M&A-firms N=136 &

non-risky-M&A-firms N=100. For the dependent variables ∆Stock grants 2004 firm-years are perceived (4 years for 501 firms) and resulted in 901 observations. For the dependent variable ∆Option grants 944 firm-years are perceived (4 years for 236 firms) and resulted in 716 observations.

For the control variables Size, Dualdummy, Age, Growth, FreeCashFlows 2004 firm-years are used. Table 2

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compensation are significant (P<0.05). For option grants in dollars and as a percentage of total CEO compensation (Option%) no significant change is reported between the completion-year and year t+3. Although the proportion of option grants (Option%) increase from 24.8% to 28.2% between the years t to t+1, a decrease is observable from 29.4% to 27.6% between the year t+2 to t+3.

The results of table 3 suggest to expect a significant increase of stock grants in the post-M&A period, given that over the year t+1, t+2 and t+3 an increasing in the proportion of stock grants (Stock%) is observed. The results seems mixed for option grants since there is no significant decrease reported in the proportion of option grants, although over the last two years the proportion of option grants slightly decreased. Hence, table 3 gives insight and discussion for interpretation regarding the changes in equity compensation, although a formal test provides objective results. The OLS regression will give objective information.

Years Stock grants ($) Option grants ($) Total Comp. ($) Stock% (for risky-M&As) Option% t Mean 2,216.40 1,305.03 5,012.82 0.302 0.248 Median 689.78 21.98 3,084.96 0.235 0.157 Stand. Dev. 3,342.53 2,184.49 4,835.14 0.316 0.283 t +1 Mean 2,679.74 1,666.65 5,725.83 0.357 0.282 Median 1,185.23 712.92 4,040.46 0.383 0.263 Stand. Dev. 3,564.96 2,224.06 4,808.26 0.312 0.271 t +2 Mean 2,731.31 1,593.17 5,733.53 0.377 0.294 Median 1,270.64 839.27 4,483.05 0.388 0.253 Stand. Dev. 3,400.81 2,077.67 4,508.51 0.313 0.291 t +3 Mean 3,075.62 1,638.01 6,056.98 0.411 0.276 Median 1,849.25 713.48 4,720.77 0.429 0.249 Stand. Dev. 3,582.47 2,303.52 4,815.56 0.306 0.268 0.1078 0.0073* 0.0192** 0.0002* 0.1723

Items in bold indicate significance at the levels P<0.01*** P<0.05**, P<0.1* p-value for the

difference in means between years t and t +3

This table provides summary statistics for stock grants and option grants in dollar value and as a proportion of total CEO compensation for the years t, t +1, t +2 and t +3. These variables are for the M&A-firms (N=236) and risky-M&A-firms (N=136).

Summary statistics of equity-compensation

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Correlation Analysis

Before running the OLS regression, table 4 provides the Pearson correlation coefficients between the independent variables M&As, risky-M&As and control variables with the dependent variable ∆Stock grants and ∆Option grants. Furthermore, table 4 provides the significance levels between the variables. The Pearson’s correlation coefficient reports which kind of relationship expected from the variables in the OLS regression models, either a positive or negative relationship. From table 4 it is seen that the correlation between M&A and ∆Stock grants is negative (-0.019). However, this negative correlation is not significant, given the p-value is lower than 0.05. Although there is no significant correlation between the control variables and the change in stock grants, the relationship for most of the control variables is in the predicted direction. Except for the control variable Size which is negative with change in stock grants. Considering the very low correlation for Size, it seems not plausible that bigger firms, according to their book value of total assets, grant less stock. Regarding the dependent variable ∆Option grants, there is no significant correlation is found with the independent variable risky-M&As. Additionally, the correlation is slightly positive. In the relationship between the control variables and the change in option grants, only the variable Age have a significant correlation (p<0.05). This means when CEO’s age increases, the change in option grants decrease. The reason could be that older CEOs are granted less options to avoid they are choosing projects with short-term performance. Furthermore the control variables Dualdummy and logarithm of FreeCashFlows have a correlation with the change option awards in a different direction than expected. The expectation was both control variables were positive.

Based on the results in table 4, the expectation for a significant change in stock grants and option grants is less evident, due to the correlations between the independent and dependent variables are very weak. Still, the OLS regression needs to give objective information.

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∆Stock grants ∆Option grants M&As risky-M&As Size Dualdummy Age Growth FreeCashFlows ∆Stock grants 1.000 ∆Option grants -0.308 1.000 M&As -0.019 - 1 Risky-M&As - 0.080 1.000 1.000 Size -0.009 0.039 0.723*** 0.765*** 1.000 Dualdummy 0.031 -0.036 0.037 0.053*** 0.032 1.000 Age 0.034 -0.078** 0.025 0.036 0.049 0.046** 1.000 Growth 0.006 0.007 0.367*** 0.457*** 0.330*** 0.061** -0.107 1.000 FreeCashFlows 0.035 -0.027 -0.582 -0.608*** -0.759 -0.031 -0.045** -0.164** 1.000 Items in bold indicate significance at the levels P<0.01***, P<0.05** and P<0.1*

Table 4

This table presents the Pearson correlation coefficients between M&As and risky-M&As and the control variables with ∆Stock grants and ∆Option grants

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Regression Analysis

This chapter closes with reporting the outcomes of the OLS regression between the variables in the empirical models 1 and 2. The OLS regression provides the most detailed analysis of hypothesis 1 and 2 which were formulated in chapter 3. Table 5 presents the OLS regression and it include the control variables and year-fixed effects. Interpreting the adjusted R-square clarifies how much of the variance is explained by the variables in the model. The adjusted R-square in panel A of table 5 reports that 5.2% of the variance in ∆Stock grants is explained by the variable M&As and the control variables. Moreover, panel A of table 5 reports a betacoefficient of -0.146 for M&As. This means the change in stock grants is -0.146 percentage points lower for M&A-firms than for non-M&A-firms. This is contradicting with hypothesis 1, which implies M&Afirms will increase stock grants after undertaken a M&A. Additionally, the coefficient of -0.146 is not significant as observed by the p-value (P>0.05). This means with or without undertaking M&A, there is practically no effect on stock grants reported. Hence, my results do not support hypothesis 1. The fact is that only 5.2% of the variance in ∆Stock grants is explained and the beta-coefficient of M&As is insignificant, provides no evidence that M&A-firms having higher stock grants than non-M&A-firms.

Panel B of table 5 presents the results of regressing the indicator variable risky M&As on ∆Option grants. The beta-coefficient between risky-M&As and ∆Option grants is positive (0.096). This means, similar to the results of M&As, contradicting results are observed for risky-M&As. The prediction was that option grants for risky-M&As were lower than for non-risky-M&A-firms. Even though the beta-coefficient is contradictive, it is significant at a 10% level (P<0.10), there is some indication that risky-M&As have a higher option grants than firms which are not engaged in risky-M&As. The adjusted R-square reports that 5.5% of the variance in ∆Option grants is explained by the variables risky-M&As and the control variables. Finally, I concluded that hypothesis 2 is not supported. The prediction that option grants are decreased in the post-M&A period is not supported with the statistical findings of the OLS regression. However, hypothesis 2 find small evidence that there is a significant difference in the option grants between risky-M&As and non-risky-M&As. Both results seem not aligned with the developed hypothesis. In the next chapter the results and implications of this study are discussed.

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Regression Analysis of change in CEO equity-compensation

Coefficient estimate p-value

Variables M&As -0.146 0.219 Size 0.022 0.107 Dualdummy 0.039 0.398 Age 0.002 0.450 Growth 0.028 0.549 FreeCashFlows 0.024 0.275 R-square adjusted 0.058 Number of observations 901

Year-fixed effects Yes

Significance levels P<0.01***, P<0.05** and P<0.1* ∆Stock grants

Panel A: regression of M&As and control variables on the ∆Stock grants

Table 5

Coefficient estimate p-value

Variables Risky-M&As 0.096 0.090* Size -0.005 0.753 Dualdummy 0.046 0.603 Age 0.002 0.365 Growth 0.009 0.811 FreeCashFlows 0.023 0.277 R-square adjusted 0.055 Number of observations 719

Year-fixed effects Yes

Significance levels P<0.01***, P<0.05** and P<0.1* ∆Option grants

Panel B: regression of risky-M&As and control variables on the ∆Option grants

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5. Discussion and Conclusion

Although there are extensive research focused on the pre-M&A period, there is less research focused on the post-M&A period and the integration issues which come along with it. Since prior literatures have already recognized an increasing trend in equity compensation to incentivize executives, this study wants to investigate the effect of mergers and acquisitions on the equity compensation of the CEOs. Especially to give insight if the firms consider the different motivational and risk-taking effects of equity compensation in the period following M&As. M&A is a popular strategy to create shareholder value, even though failure rates are estimated between 60% and 80%. The integration process of M&As is highly important to create synergy between the target and acquiring firm. To stimulate decisions in which resulted in maximizing shareholder value, the expectation is that firms actively manage the CEO’s equity-components to align with the managerial behaviour in the integration process of the target and the acquiring firm. The equity compensation of M&A-firms is investigated for the years 2005 until 2016.

The results of the OLS regression show that stock grants of M&A-firms are not significantly higher than non-M&A-firms. This is contrary with my prediction, which was stock grants of CEOs are increased in the post-M&A period to align the goals of the firm and the personal wealth of CEOs. Moreover I predicted option grants are decreased in the post-integration period of risky-M&As. Prior literatures confirmed option grants increase the risk-taking behaviour of CEO. Risky-risk-taking behaviour should be limited in firms who are engaged in risky-M&As to consider a carefully integration process which result in a successful M&A on the long-term. These expectations are not supported with the results from the OLS regression. The results show that option grants of risky-M&A-firms are not significantly lower than for non-risky-M&A-firms.

This study contributes to the existing literature. Firstly, the concept strategic intentions of an organization reflected by the type of incentives (Baking and Meija, 1987), is not necessarily applicable for M&A based on the results of the OLS regression. The usual long-term strategy of M&A directed on the integration of human and organizational resource issues is not supported with an increase in stockownership. Based on extensive literature review I had chosen to investigate one side of the medal. Another potential explanation could be that firms are not trying to stimulate CEO’s effort and their commitment in the long-run, but conversely to stimulate more short-term performance. The market is unsure about the potential outcomes of M&A. To avoid the spread of uncertainty among customers, CEOs could get incentives in order to focus on shortsighted effort and to finish the integration process as fast as possible.

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Additionally, this explanation is also aligned with the weak yet significant evidence that option grants are increased in the post-M&A period for risky-M&A-firms in comparison with non-risky-M&A-firms. Granting options in a larger extend to firms engaged in risky-M&As could indicate that firms want to speed up the completion of the integration process and stimulate decisions which are shareholder value maximizing. CEOs option grants could be increased to overcome risk-averse behaviour in the integration process. This leads to the second contribution of this research. This study observes the risk exposed from risky-M&A does not have influence in structuring option grants. The discussion that option grants have different motivational effects from stock grants can still hold. Nevertheless, the implication that option grants result in risk-taking behaviour (Dong, Wang and Xie, 2010) as investigated is not supported, since the results indicate that option are granted to avoid risk-averse behaviour in the integration process.

Limitations and further research

The first limitation of this study is the control group for non-risky-M&A-firms is quite small. 100 control firms is relatively less and reduce the fact that the data sample reflects the population. Future research could enlarge the control group. Secondly, this study was based on the findings of prior literature which indicate that it takes some time before compensation structures are affected by M&As (Guest, 2009). If this does not apply on the selected data sample, it has negative influence on the predicted results. Additionally, extensive research has investigated the pre-M&A period and incentive structures. Possibly the acquiring firms already prepare the incentive structure in advance, thus integration issues are carefully approached by CEOs since the beginning of the acquiring process. Therefore, using different analytical methods could give different results. Future research could compare the level of pre-M&A and post-M&A equity compensation to complement the findings of this study. Moreover, future research could investigate whether firm performance is different for companies who adjust CEO’s option grants with firms who do not adjust CEO’s option grants in the post-M&A period. Although many studies have focused on the assessment of post-M&A firm performance, more thorough research can explore the optimal incentive structure to achieve the highest chance for a successful M&A.

Conclusively, firms are not considering stockownership in structuring CEO’s compensation after undertaken M&A. Furthermore, small evidence is provided that firms consider to increases option grants when they are faced with a high integration risk of the acquiring and target firm. This provide indication that firms use option grants to overcome risk-averse behaviour in the integration process to speed up the uncertain outcome of M&As.

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Increase option grants should therefore contribute to maximizing shareholder value. Future research could investigate this implication.

The effect of M&As on equity compensation