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Long-term incentivesMoqi Groen-Xu, London School of Economics
Prepared for LBS governance conferenceJune 2, 2015
Method Data Yearly Qrt/Mth Summary Whatevs4/21
Classic Example Noda-Bower (1996): Investment into wireless communication in the 1980s
high uncertainty about potentialproduct scope and technology not clear
Example
Whatevs5/21
• one of “Bells” from AT&T breakup
• required quick break-even and high net income contribution
• “cream-skimming”• diversification into real estate
US West vs BellSouth
US West Bell South
• one of “Bells” from AT&T breakup
• emphasis on growth in project selection
• CEO with “pet projects”
• heavy investment into cellular market
Strategy
Method Data Yearly Qrt/Mth Summary Whatevs6/21
• learn about payoff distribution of ideas
Two stages of investment (Manso)
Exploration Exploitation1 2
• invest into project with best (known) payoff distribution
Method Data Yearly Qrt/Mth Summary Whatevs8/21
How can we set long-term incentives?
Equity compensation Fixed-term contracts
Method Data Yearly Qrt/Mth Summary Whatevs9/21
Joint work with • Alex Edmans• Luis Goncalves-Pinto• Yanbo Wang
Looks at the effects of equity vesting on the timing of news releases
Two studies
Compensation Contract length1 2
Joint work with• Juanita Gonzalez-Uribe
Looks at the effects of contract horizon on innovation (patenting activity)
Method Data Yearly Qrt/Mth Summary Whatevs10/21
Long-term equity compensation
• Example: John Eyler/Toys”R”Us• Source: Filing 4/Proxy statement footnotes• On average 3 years of vesting per grant
Patricia Russo at Lucent
Whatevs13/21
2002 2003 2004 2005 2006 2007
Appointment
T-5 T-4 T-3 T-2 T-1 T
Data Results Qrt/Mth Summary Whatevs
0%
2%
4%
6%
8%
10%
12%
5 4 3 2 1
Remaining years
All contracts
0%
2%
4%
6%
8%
10%
12%
5 4 3 2 1
Remaining years
Renewed contracts
14/25
Contract termination
Method Data Yearly Qrt/Mth Summary Whatevs16/21
News releases lead to a temporary increase in stock price and trading volume
Executives personally benefit from news releases shortly before they sell
Strategic news releases
Method Data Yearly Qrt/Mth Summary Whatevs18/21
• Today: news releases• Incentives for the upside• Can be replenished over
time: set long- and short term incentives at the same time
Long term incentives in comparison
Compensation schedule Contract length
• Today: innovation• Tolerance for failure• Hard to replenish over
time – “evergreen” contracts set incentives until the next renewal date
Innovation
Whatevs19/21
T-5 T-4 T-3 T-2 T-10
0.1
0.2
0.3
0.4
0.5
0.6
0.795% Confidence IntervalCoefficient Estimate
Time to contract expiration
Scal
ed p
aten
t cita
tions
Exploration and exploitation
Whatevs20/21
CEOs with less time remaining under contract produce patents that are
• More focused (less dispersion throughout technology classes)
• Less varied in quality variety
• Less general (more dispersion across technology classes of subsequent innovations that cite the patent)
• Less likely to be in a technology class new to the firm
• Less likely to be filed by a new inventor
• More likely to be based on prior innovations filed by the firm
T-5 T-4 T-3 T-2 T-1
-0.2
-0.15
-0.1
-0.05
0
0.05 Technological focus
-1012345678 Quality variety