Stock-Based Compensation in a Concentrated Ownership Setting: An Empirical Investigation

Stock-based compensation has been viewed as an important mechanism for tying managers' wealth to firm performance, and thus alleviating the agency conflict between the shareholders and the managers when ownership is diffused. However, in a concentrated ownership structure, controlling owners are usually the management of the firm; they can engage in self-dealing activities to the detriment of minority shareholders' interests. Yet, outside investors may anticipate the problem and discount the share price for the entrenchment behaviors they observe. In this study, we investigate how controlling owners trade off the benefits and the costs of using stock-based compensation. Based on a sample of Taiwanese firms, our evidence shows that stock-based compensation is negatively related to the agency problem embedded in a concentrated ownership structure. This relationship is evident among firms with more frequent equity offerings. Overall, our empirical evidence suggests that controlling owners consider the negative price effects of stock-based compensation and trade off these costs with the benefits of expropriating minority shareholders' interests, particularly when firms seek more external equity capital. Our results hold after controlling for selection bias and share collateral by controlling owners.