STOCK MARKET REACTION TO MANAGEMENT INCENTIVE PLAN ADOPTION An Overview

The papers by Brickley, Bhagat and Lease ('The Impact of Long-Range Managerial Compensation Plans on Shareholder Wealth') and by Tehranian and Waegelein ('Market Reaction to Short-Term Executive Compensation Plan Adoption') examine stock price performance around the time firms adopt management incentive plans. Each paper finds positive stock price performance. In this overview, I integrate the evidence presented in these two stimulating papers, and suggest additional tests of important economic hypotheses. Before discussing the details of the two papers, I have some observations on the overall picture that emerges from the studies. First, the general conclusion of positive stock price performance around the time of incentive plan adoption is strongly supported by the evidence in the two papers, and is not due to some methodological quirk. In light of these two papers (with different samples yet similar results) and of Larcker's (1983) findings along the same lines, it is difficult to argue that incentive plans are merely an 'excessive perk' whose adoption hurts shareholders. Second, there is evidence on reasons for the positive stock price performance. The evidence supports two views. One is that plan adoption leads to higher stock prices, via, for example, incentive effects. An alternative view is that higher stock prices lead to plan adoption: some of the data suggest the possibility that firms adopt plans after a period of favorable performance, and the data are consistent with the notion that plan adoption takes place in expectation of future stock price increases, that is, when management has favorable inside information about the firm's future prospects. As I shall