Going short‐term or long‐term? CEO stock options and temporal orientation in the presence of slack

• DOI: http://doi.org/10.1002/smj.2445
• Published date: 01 December 2016
• Date: 01 December 2016

Strategic Management Journal

Strat. Mgmt. J.,37: 2463–2480 (2016)

Published online EarlyView 17 November2015 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2445

Received 2 May 2014;Final revision received11 June 2015

GOING SHORT-TERM OR LONG-TERM? CEO STOCK

OPTIONS AND TEMPORAL ORIENTATION IN THE

PRESENCE OF SLACK

GEOFFREY P. MARTIN,1*ROBERT M. WISEMAN,2

and LUIS R. GOMEZ-MEJIA3

1Melbourne Business School, University of Melbourne, Melbourne, Australia

2Department of Management, Eli Broad Graduate School of Management, Michigan

State University, East Lansing, Michigan, U.S.A.

3Department of Management, Mendoza College of Business, University of Notre

Dame, Notre Dame, Indiana, U.S.A.

Research summary: We draw on behavioral agency theory to explain how decision heuristics

associated with CEO stock options interact with rm slack to shape the CEO’s preference for

short- or long-term strategies (temporal orientation). Our ndings suggest CEO current option

wealth substitutes for the inuence of slack resources in encouraging a long-term orientation,

while prospective option wealth enhances the positive effect of slack on temporal orientation.

Our theory offers explanations for non-ndings in previous analysis of the relationship between

CEO equity based pay and temporal orientation and provides the insights that CEO incentives

created by stock options (1) enhance the effect of available slack upon temporal orientation and

(2) can both incentivize and de-incentivize destructive short-termism, depending upon the values

of current and prospective option wealth.

Managerial summary: Weexplore how compensation design can play a role in affectingthe CEO’s

preference for short- or long-term strategic projects. When the CEOs have accumulated option

wealth, they are more likely to invest in the long term. Yet when they have a large number of

recently granted options with the potential to generate signicant wealth in the eventof successful

risk taking, the CEO is morelikely to prefer the short term in order to achieve personal wealth gains

more quickly.The more liquid assets the rm holds, the weaker both of the aforementioned effects.

An implication for boards is that they should anticipate CEO short-termism if the CEO has been

granted new options, underlining the potential negative consequences of option compensation.

Copyright © 2015 John Wiley & Sons, Ltd.

INTRODUCTION

Managerial short-termism— particularly in the

United States— has been described as both

widespread and destructive by various management

Keywords: executive compensation; loss aversion; CEO

decision making; temporal orientation; available slack

*Correspondence to: Geoffrey P. Martin, Melbourne Business

School, University of Melbourne, 200 Leicester Street, Carlton

VIC 3053, Australia. E-mail: g.martin@mbs.edu

Copyright © 2015 John Wiley & Sons, Ltd.

scholars (Drucker, 1986; Jensen and Murphy,

1990; Laverty, 1996; Marginson and McAulay,

2008; Mueller and Reardon, 1993; Walsh and

Seward, 1990). Short-termism becomes an agency

problem when managers sacrice longer run prof-

itability in favor of shorter term prots, motivated

by private gains and temporal preferences (c.f.,

Jensen, 2008; Jensen and Murphy, 1990; Walsh and

Seward, 1990). Some shareholders may also have

a short-term outlook (Bolton, Scheinkman, and

Xiong, 2006) meaning that short-termism may not

2464 G. P. Martin, R. M. Wiseman, and L. R. Gomez-Mejia

always lead to incentive misalignment problems

between managers and shareholders. However,

one nds an unusual consensus in management

literature that preoccupation with short-term share

price gains is at the expense of longer-term value

creation, implying that short-termism is inconsis-

tent with the goals of all but short-term oriented

investors. As noted by Peter Drucker, pressure

by capital markets for positive quarterly growth

“…constantly pushes top managements toward

decisions they know to be costly, if not suicidal,

mistakes.” (1986: 32). Consistent with this view,

the negative ramications of short-termism have

been discussed by many high prole public gures

and regulatory committees as having contributed

to the severity of the Great Recession (e.g.,

Basel Committee on Banking Supervision, 2009;

Geithner, 2009; Gigler et al., 2014). The value

creation associated with a longer term managerial

focus suggests that shareholders with extended

horizons (e.g., Berkshire Hathaway) and other

important stakeholders— employees, customers

and the economy as a whole— have a keen interest

in ensuring executives adopt a longer temporal

orientation.

Despite the widely held view that temporal ori-

entation is instrumental to rm survival and the

prosperity of the economy as a whole, the theoret-

ical frameworks used to explore this phenomenon

remain underdeveloped. A rst step in this direc-

tion was achieved by Souder and Bromiley (2012)

who drew upon behavioral theory of the rm to

determine if temporal orientation is driven by rm

performance or incentive alignment using stock

options. While they nd support for the role of

performance and available slack, they failed to

nd evidence that stock options inuenced tempo-

ral orientation, leading them to conclude that it is

“interesting that we cannot nd evidence support-

ing one of the conceptual tenets justifying stock

grants” (pp. 563). These conclusions suggest that

there is a need to go in search of novel theoret-

ical approaches to explain the link between CEO

compensation and rm temporal orientation. We

argue that the lack of support for agency-based pre-

dictions regarding the relationship between CEO

stock option pay and temporal orientation rests on

the failure of traditional agency theory to account

for and incorporate the ndings of behavioral

research— and in particular, the insight that agent

equity grants do not consistently lead to alignment

of interests between agent and principal (Martin,

Gomez-Mejia, and Wiseman, 2013; Wiseman and

Gomez-Mejia, 1998).

The fusion of prospect theory with agency the-

ory in behavioral agency research has been instru-

mental in enhancing our conception of risk in

explaining the relation of incentives to agent risk

taking (cf. Wiseman and Gomez-Mejia, 1998). The

theories are considered complimentary given that

(1) agency theory suggests the managerial agent

will behave opportunistically, necessitating incen-

tive alignment mechanisms that limit the costs

opportunism imposes upon shareholders and (2)

prospect theory facilitates the prediction of indi-

vidual decision making in response to uncertain

future outcomes regarding personal wealth. In com-

bining these theories, behavioral agency research

has shown how, in response to equity incentives,

opportunistic agents (CEOs) use heuristics when

making strategic choices that will effect personal

wealth through their impact upon rm performance

and the share price (e.g.,. Devers et al., 2008;

Larraza-Kintana et al., 2007; Martin, et al., 2013).

An important theoretical advancement that has

emerged from behavioral agency research is that

agent choice is best characterized as a mixed gamble

in which both gains and losses are possible (Bromi-

ley, 2009; Martin etal., 2013). That is, agents make

decisions in a context of uncertainty in which their

strategic choices have the potential for both posi-

tive and negative consequences to personal wealth.

In addition, agents value these consequences dif-

ferently by giving more weight to possible losses

than to equal amounts of gain. This “loss aversion”

reects an inherent preference for avoiding losses

relative to attracting gains (Tversky and Kahneman,

1991). Finally, agents are myopic in their prefer-

ence for avoiding losses by discounting losses in

the future relative to losses in the present (Thaler

et al., 1997). In combination, these positivist nd-

ings regarding agent choice behavior provide a

foundation for examining the role of incentives in

shaping temporal orientation.

In this study, we extend behavioral agency

research by examining how agent incentives may

inuence a rm’s temporal orientation in the

presence of available slack (resources available to

fund adaptation or strategic initiatives; March and

Simon, 1958). Though prior research examined

intertemporal preferences of decision makers (e.g.,

Benartzi and Thaler, 1995, 1999; Chrisman and

Patel, 2012), the linkage between research on

individual choice under uncertainty and temporal

Copyright © 2015 John Wiley & Sons, Ltd. Strat. Mgmt. J.,37: 2463–2480 (2016)

DOI: 10.1002/smj