Wednesday, March 11, 2015

Monday, March 9, 2015

Do CEOs time option grants relative to stock splits?

This post is based on a paper coauthored with Erik Devos of UTEP and Bill Elliott of John Carroll University.



To answer this question, we need a quick recap of options and splits.

Stock option grants frequently make up a significant portion of CEOs' compensation packages.  Typically an option is granted to the CEO "at the money" meaning that the strike price is set close to trading price of the stock.  If the stock price increases after the option grant, the value of the option will increase.  This is a standard property of call options and is the prima facie reason for granting them in the first place.

Stock splits are, by and large, cosmetic changes to the stock.  A 2 for 1 stock split results in each share of stock being replaced with 2 shares.   In such a split, the stock price should fall in half, so a $100 stock will split to two $50 stocks.   In reality, the $100 stock splits (on average) into two $51.50 stocks.   In effect a $3 or 3% gain in value occurs on the announcement day of the split.  The key thing to note here is that this is "on average".  Why this occurs is a bit of a mystery and beyond our discussion today.

So given these two factoids - options are granted at the money and stock splits result in a price increase (split adjusted) - when would a CEO most likely want to get an option grant?  
A. Before the split announcement.
B. After the split announcement.
C. The CEO shouldn't care.


If you answered A, then you'd be right - and this is supported by the data.


This figure shows the number of grants made relative to the split announcement.  Clearly, there is clustering before the announcement on day 0.  So what's going on?

Because a grant is granted "at the money", the 3% price bump that occurs on the split announcement results in an immediate increase in value for the holder of the option.  Therefore a CEO would prefer to get his/her options before the split rather than after it. 

But the story is more tricky - as this result holds for scheduled grants (grants which occur at a pre-determined time each year).  This means that in some cases the split announcement is being timed relative to the grant.

OK but so what?

On average, by granting before the split, a CEO will see his/her wealth increase by more than $450,000!   This is based on the size of the grant and the effect that a 3% stock price increase has on the value of the option.

In case you are wondering, CEOs also appear to time their stock trades relative to split announcements.



These findings are forthcoming in the Journal of Accounting and Economics in the following paper:

“CEO Opportunism?: Option Grants and Stock Trades around Stock Splits” 
Erik Devos, William Elliott, Richard S. Warr
Forthcoming: Journal of Accounting and Economics.

A copy is available for download on my website.

Friday, February 13, 2015

Flash Boys - my review

I finally got around to reading "Flash Boys" by Michael Lewis.   Bottom line, like a lot of non-fiction books, it is pretty good, but probably could be half as long.

The basic story, in case you haven't read it is as follows {SPOILER ALERT}

  • RBC Equity trader suspects that his trades are being front run  - someone is anticipating his moves and then picking off his juicy trades by jacking the price very slightly.
  • After much research (using LinkedIn and experts in fibre optic cables) he figures out the problem.
    • The fragmented nature of equity markets - there are more than 30 equity trading venues - coupled with the speed at which information flows from one market to another - allows high frequency traders to lure trades to one market then pull back depth and pick off the trade at the next market.
    • The solution is to slow down trades
  • RBC Equity trader quits his day job and creates a new exchange which works on the idea that by slowing down trading, you remove the advantage to the HFT guys.
  • After a slow start, the new exchange does really well, because people hate getting ripped off the by the HFT guys.   
  • The exchange is still going:  http://www.iextrading.com/
There are a couple of side stories.  Apparently someone is laying fibre from New York to Chicago.   Also a coder goes to jail for apparently stealing open source code from Goldman.  But really he wasn't a bad guy.

Overall, worth a read if you are interested in HFT, but if you are not, then it's a pretty geeky book and probably not worth the effort.

The broader takeaway from the book is that a huge amount of money is being made from HFT.   Because HFT isn't a value creating enterprise, and the stock market is basically a zero-sum game, this means that this money is coming from investors.  Investors who have money in pension funds and mutual funds etc.  People like me.

Bottom line.  To quote Josh Brown: "The way to defeat high frequency traders is to be a low frequency trader"

Thursday, February 12, 2015

Buffett's bet against a Hedge Fund manager

We're in year 6 of Warren Buffett's million dollar bet against Hedgie Ted Seides.   Buffett bet that the S&P 500 index would crush a portfolio of hedge funds hand picked by Seides.

So far, Buffett is correct.  The index is stomping on the hedge funds.

Of course, there's no surprise here.  If you are interested in long term capital appreciation a portfolio of indexed stocks will virtually always outperform a fund that is charging 2/20 and is run by people who think that they are smarter than the market.

What's amusing is that Seides is now coming up with excuses for why it's not a fair competition.  You can read them here

Thanks to my accounting colleague, Don for the link.

Wednesday, January 7, 2015

NC State Jenkins Online MBA is ranked #9 by US News.

Fantastic news today.  Our online MBA program is ranked #9 by US News.  From the beginning, we focussed on creating a very high quality experience for our students, and it's nice to see that this focus has paid off.


For details about the Jenkins MBA - check out this link.

Friday, December 19, 2014

The efficient frontier works ... in the long run.

Wonderful post by Cliff Asness that shows in the short run the basic tenets of risk and return seem to get all jumbled up (bonds earning more than stocks, etc), but in the long run it all works out.

That's the point.   In the long run it all works out.   Trashing finance theories because they didn't work this week is stupid.  As is basing asset allocation decisions on short term performance and market conditions.  

Here's the conclusion it all of its finance theory supporting beauty.


Wednesday, December 17, 2014

ESOP at a grocery store

Apparently the employees of the Winco grocery chain are doing very well in the retirement department, thanks to an ESOP (employee share ownership plan).  

This Forbes article gushes about awesome this all is, but makes no mention of the elephant in the room.   I'll give you a hint:  Nobody at Enron ever thought that their retirement plans would become worthless overnight!!  

So while the ESOP makes a lot of sense in some ways, in other ways, the employees are horribly un-diversified.  They are one very bad salmonella outbreak away from loosing their jobs and their savings.

Wednesday, December 3, 2014

AQR puts data library online

AQR - the investment firm, has published the data sets used in its research papers.   A great resource for those interested in testing out momentum and other strategies!

https://www.aqr.com/cliffs-perspective/introducing-the-aqr-data-library

Tuesday, November 18, 2014

Do the portfolios of finance professionals underperform?

Apparently, using data from "the yelp of investing", it has been discovered that finance professionals underperform advertising and tech professionals when it comes to investing.

At first blush, this finding seems consistent with yet another failure for finance.  But I think the truth is somewhat less exciting.  I am guessing that finance professionals are far more diversified and more conservative in their investments.   A point that is raised in the article.

Further on there is discussion of a research paper that finds that finance experts don't beat regular folks when it comes to mutual funds.  Again, I don't think that there is much surprise here for the simple reason that markets are efficient.  Being an expert in finance doesn't make you able to predict the future.

Ironically, being an expert in finance does tell you that you shouldn't pay big fees to experts in finance to run your money.   You should index.