Out-of-the-Money CEOs: Private Control Premium and Option Exercises

When a proxy contest is looming, the rate at which CEOs exercise options in order to sell (hold) the resulting shares slows down by 80% (accelerates by 60%), consistent with their desire to maintain or strengthen voting rights when facing control challenges. Such deviations are closely aligned with features unique to proxy contests such as the record dates and nomination status. Moreover, a contest triples the probability that an insider exercises options out-of-the-money, an irrational strategy under conventional models. The various distortions suggest that incumbents value their stocks 5% – 10% higher than the market price when the voting rights embedded in the shares are valuable for defending control and preserving private benefits.