Stock Option Grants to Target CEOs during Merger Negotiations

Many target CEOs receive unscheduled stock option awards during merger negotiations which become immediately exercisable when the acquisition is completed. We find an inverse association between the size of golden parachutes given to target CEOs and the probability that these executives receive unscheduled options during merger negotiations. These unscheduled awards are also more likely to be issued when CEOs expect large compensation losses if their firms are sold. Consistent with option backdating, we find that (1) grant dates are systematically set to benefit CEOs, and (2) the grants’ post-issuance performance increases with the awards’ reporting lag. After the Sarbanes-Oxley Act promulgation, backdating episodes decline, but the exercise premiums target CEOs realize on unscheduled options exceed the takeover premiums their shareholders receive by over 25 percent. Our results indicate that the Act has curtailed the targets’ ability to backdate stock options, but not their ability to favorably time these awards. JEL classification: G30; G34; J33; K22