This paper finds that CEO stock options influence the choice, amount, and timing of funds distributed as a buyback. These results support two research expectations–that buybacks impose option-induced agency costs on outside shareholders, and that managers benefit from weak governance and unclear accounting in this choice. Increased CEO insider selling following a buyback also supports this agency cost perspective. Once we control for these option-related factors, we find no evidence that buyback activity associates reliably with EPS accretion from the reduction in common shares. We conclude that the popular use of buybacks as a form of cash distribution derives significantly from a strong contemporaneous relation between stock buybacks and CEOs’ use of stock options as compensation.
UC Davis, Graduate School of Management
June 2, 2011