Joint with John Core, Wayne Guay
Last Revised January 7 2015
We find that US CEOs hold a large amount of equity that is not explicitly constrained by ownership guidelines or vesting requirements. There is considerable debate as to why CEOs might hold seemingly unconstrained equity, particularly given that executives are widely assumed to be risk averse and poorly diversified. We explore several potential explanations for these unconstrained holdings. We begin by showing that the average CEO receives a pay premium for holding a substantial portion of this equity, suggesting that what might at first appear to be unconstrained equity, may in fact, be implicitly required by the board for incentive contacting purposes. Most CEOs, however, hold more equity than one would expect given the magnitude of the risk premium in their pay. We explore reasons why these CEOs appear to hold equity voluntarily, including subjective or objective beliefs about undervalued share price, or comparatively low risk aversion. We estimate models that allow for heterogeneity in the determinants of equity holdings across CEOs. Our estimates indicate that there is considerable variation in the determinants of holdings across CEOs. In particular, we find that CEOs tend to hold more equity when they are more risk-tolerant and when they have more power. We find little evidence that over-confidence or inside trading explains holdings. Overall, our results suggest that traditional OLS models of the conditional mean level of equity holdings fail to capture the significant variation that exists across CEOs.