Essays on the role of executive compensation in the subprime mortgage crisis and the incentive effects of executive stock options

Sun, Yuanyuan

Permalink

https://hdl.handle.net/2142/49754 Copy

Description

Title

Essays on the role of executive compensation in the subprime mortgage crisis and the incentive effects of executive stock options

Author(s)

Sun, Yuanyuan

Issue Date

2014-05-30T17:07:59Z

Director of Research (if dissertation) or Advisor (if thesis)

Olson, Craig A.

Doctoral Committee Chair(s)

Olson, Craig A.

Committee Member(s)

• Aguilera, Ruth V.
• Shin, Taekjin
• Laschever, Ron A.

Department of Study

School of Labor & Empl. Rel.

Discipline

Human Res & Industrial Rels

Degree Granting Institution

University of Illinois at Urbana-Champaign

Degree Name

Ph.D.

Degree Level

Dissertation

Keyword(s)

• Executive Compensation
• Mortgage Origination
• Stock Options
• Underwater Options

Abstract

This thesis examines executive compensation and consists of two chapters. The first chapter studies the relationship between executive equity incentives in banking firms and mortgage origination prior to the 2008 financial crisis, and aims at directly answering whether executive compensation in the financial sector contributed to the mortgage market meltdown in the most recent financial crisis. By constructing a unique data set of CEO compensation in a very inclusive sample of publicly-traded banks in the US from 1999 to 2005, and using comprehensive loan application records from 2000 to 2006, this study provides reliable evidence of the link between executive compensation in banking firms and the growth of high-risk mortgages that were a root cause of the financial crisis. Empirical evidence from this study shows that banks where CEOs had higher pay-for-performance sensitivities from equity compensation originated riskier mortgages, characterized by higher loan-to-income ratio, prior to the crisis. The second chapter examines firms’ new option grants in response to executive underwater options. A unique data set was constructed that contains detailed information of each option grant in CEOs’ total option portfolio at each time when firms made a new option grant. The results show that firms increased the number of new options in response to CEOs’ underwater options following the 2008 financial crisis. The number of new options increased with the number of underwater options held by CEOs, as well as the extent to which the options were underwater. In contrast, firms did not take specific measures to compensate for the intrinsic value loss from in-the-money options. The results are consistent with the previous research on option repricing, and further confirm that the new and larger options are used as an alternative to option repricing, or as a form of “backdoor repricing”, in response to executive underwater options.

Graduation Semester

2014-05

Permalink

http://hdl.handle.net/2142/49754

Copyright and License Information

Copyright 2014 Yuanyuan Sun

Owning Collections