Essays on Stock Option Compensation and the Role of Incentives and Risk (summary section only)

Managerial pay-for-performance sensitivity has increased rapidly around the world. Early empirical research showed that pay-for-performance sensitivity resulting from stock ownership and stock options appeared to be quite low during the 1970s and early 1980s in the U.S. However, recent empirical research from the U.S. shows an enormous increase in pay-for-performance sensitivity. The global trend has also reached Finland, where stock options have become a major ingredient of executive compensation. The fact that stock options seem to be an appealing form of remuneration from a theoretical point of view combined with the observation that the use of this compensation form has increased significantly during the recent years, implies that research on the dynamics of stock option compensation is highly relevant for the academic community, as well as for practitioners and regulators. The research questions of the thesis are analyzed in four separate essays. The first essay examines whether stock option compensation practices of Finnish firms are consistent with predictions from principal-agent theory. The second essay explores one of the major puzzles in the compensation literature by studying determinants of stock option contract design. In theory, optimal contract design should vary according to firm characteristics. However, in the U.S., variation in contract design seems to be surprisingly low, a phenomenon generally attributed to tax and accounting considerations. In Finland, however, firms are not subject to stringent contracting restrictions, and the variation in contract design tends, in fact, to be quite substantial. The third essay studies the impact of price- and risk incentives arising from stock option compensation on firm investment. In addition, the essay explores one of the most debated questions in the literature, in particular, the relation between incentives and firm performance. Finally, several strands of literature in both economics and corporate finance hypothesize that economic uncertainty is related to corporate decision-making. Previous research has shown that risk tends to slow down firm investment. In the fourth essay, it is hypothesized that firm risk slows down growth from a more universal perspective. Consistent with this view, it is shown that risk not only tends to slow down firm investment, but also employment growth. Moreover, the essay explores whether the nature of firms’ compensation policies, in particular, whether firms make use of stock option compensation, affects the relation between risk and firm growth. In summary, the four essays contribute to the current understanding of stock options as a form of equity incentives, and how incentives and risk affect corporate decision-making. By this, the thesis promotes the knowledge related to the modern theory of the firm.

Stock Option Compensation in Finland: An Analysis of Economic Determinants, Contracting Frequency, and Design

This paper addresses several questions in the compensation literature by examining stock option compensation practices of Finnish firms. First, the results indicate that principal-agent theory succeeds quite well in predicting the use of stock options. Proxies for monitoring costs, growth opportunities, ownership structure, and risk are found to determine the use of incentives consistent with theory. Furthermore, the paper examines whether determinants of stock options targeted to top management differ from determinants of broad-based stock option plans. Some evidence is found that factors driving these two types of incentives differ. Second, the results reveal that systematic risk significantly increases the likelihood that firms adopt stock option plans, whereas total firm risk and unsystematic risk do not seem to affect this decision. Third, the results show that growth opportunities are related to time-dimensional contracting frequency, consistent with the argument that incentive levels deviate more rapidly from optimum in firms with high growth opportunities. Finally, the results suggest that vesting schedules are decreasing in financial leverage, and that contract maturity is decreasing in firm focus. In addition, both vesting schedules and contract maturity tend to be longer in firms involving state ownership.

Oligarchs, political regime changes, and firm valuation

This paper examines the impact of a regime shift on the valuation of politically powerful oligarch firms. Focusing on the Yeltsin-Putin regime shift in Russia, we find that the valuations of outside shareholders claims are significantly higher under the Putin regime than under the Yeltsin regime after controlling for industry and time effects. The findings suggest that the increasing cost of extracting private benefits outweigh the reduction in the value of political connections following the political regime change. The results are also consistent with changes in the risk of state expropriation. Our results show that effects driven by the political regime change complement the traditional view stating that increased ownership concentration improved the performance of Russian oligarch firms.

A Model for Creating Strategic Alliances. A Study of Inter-firm Cooperation in the North European ICT Sector

In this study, it is argued that the view on alliance creation presented in the current academic literature is limited, and that using a learning approach helps to explain the dynamic nature of alliance creation. The cases in this study suggest that a wealth of inefficiency elements can be found in alliance creation. These elements can further be divided into categories, which help explain the dynamics of alliance creation. The categories –combined with two models brought forward by the study– suggest that inefficiency can be avoided through learning during the creation process. Some elements are especially central to this argumentation. First, the elements related to the clarity and acceptance of the strategy of the company, the potential lack of an alliance strategy and the elements related to changes in the strategic context. Second, the elements related to the length of the alliance creation processes and the problems a long process entails. It is further suggested that the different inefficiency elements may create a situation, where the alliance creation process is –sequentially and successfully– followed to the end, but where the different inefficiencies create a situation where the results are not aligned with the strategic intent. The proposed solution is to monitor and assess the risk for inefficiency elements during the alliance creation process. The learning, which occurs during the alliance creation process as a result of the monitoring, can then lead to realignments in the process. This study proposes a model to mitigate the risk related to the inefficiencies. The model emphasizes creating an understanding of the other alliance partner’s business, creating a shared vision, using pilot cooperation and building trust within the process. An analytical approach to assessing the benefits of trust is also central in this view. The alliance creation approach suggested by this study, which emphasizes trust and pilot cooperation, is further critically reviewed against contracting as a way to create alliances.

The impact of stock option incentives on investment and firm value

This paper analyzes the relations among firm-level stock option portfolio incentives, investment, and firm value based on a sample of Finnish firms during the time period 1987 – 2000. Utilizing exact and complete information regarding stock option portfolio characteristics, we find some evidence that firm investment is increasing in the incentives to increase stock price (delta) and risk (vega). Furthermore, we find strong evidence of a positive relation between both incentive effects and firm value (Tobin’s Q). In contrast, when we allow for stock option incentives, investment, and firm value to be simultaneously determined, we find no evidence that investment is increasing in incentives. However, even after controlling for endogeneity, we find that both incentive effects arising from stock option compensation display a positive and significant effect on firm value. Finally, in contradiction to earlier findings, we observe that neither Tobin’s Q nor investment drives incentives.

Fatigued driving : prevalence, risk factors and groups, and the law

Fatigue and sleepiness are major causes of road traffic accidents. However, precise data is often lacking because a validated and reliable device for detecting the level of sleepiness (cf. the breathalyzer for alcohol levels) does not exist, nor does criteria for the unambiguous detection of fatigue/sleepiness as a contributing factor in accident causation. Therefore, identification of risk factors and groups might not always be easy. Furthermore, it is extremely difficult to incorporate fatigue in operationalized terms into either traffic or criminal law. The main aims of this thesis were to estimate the prevalence of fatigue problems while driving among the Finnish driving population, to explore how VALT multidisciplinary investigation teams, Finnish police, and courts recognize (and prosecute) fatigue in traffic, to identify risk factors and groups, and finally to explore the application of the Finnish Road Traffic Act (RTA), which explicitly forbids driving while tired in Article 63. Several different sources of data were used: a computerized database and the original folders of multidisciplinary teams investigating fatal accidents (VALT), the driver records database (AKE), prosecutor and court decisions, a survey of young male military conscripts, and a survey of a representative sample of the Finnish active driving population. The results show that 8-15% of fatal accidents during 1991-2001 were fatigue related, that every fifth Finnish driver has fallen asleep while driving at some point during his/her driving career, and that the Finnish police and courts punish on average one driver per day on the basis of fatigued driving (based on the data from the years 2004-2005). The main finding regarding risk factors and risk groups is that during the summer months, especially in the afternoon, the risk of falling asleep while driving is increased. Furthermore, the results indicate that those with a higher risk of falling asleep while driving are men in general, but especially young male drivers including military conscripts and the elderly during the afternoon hours and the summer in particular; professional drivers breaking the rules about duty and rest hours; and drivers with a tendency to fall asleep easily. A time-of-day pattern of sleep-related incidents was repeatedly found. It was found that VALT teams can be considered relatively reliable when assessing the role of fatigue and sleepiness in accident causation; thus, similar experts might be valuable in the court process as expert witnesses when fatigue or sleepiness are suspected to have a role in an accident’s origins. However, the application of Article 63 of the RTA that forbids, among other things, fatigued driving will continue to be an issue that deserves further attention. This should be done in the context of a needed attitude change towards driving while in a state of extreme tiredness (e.g., after being awake for more than 24 hours), which produces performance deterioration comparable to illegal intoxication (BAC around 0.1%). Regarding the well-known interactive effect of increased sleepiness and even small alcohol levels, the relatively high proportion (up to 14.5%) of Finnish drivers owning and using a breathalyzer raises some concern. This concern exists because these drivers are obviously more focused on not breaking the “magic” line of 0.05% BAC than being concerned about driving impairment, which might be much worse than they realize because of the interactive effects of increased sleepiness and even low alcohol consumption. In conclusion, there is no doubt that fatigue and sleepiness problems while driving are common among the Finnish driving population. While we wait for the invention of reliable devices for fatigue/sleepiness detection, we should invest more effort in raising public awareness about the dangerousness of fatigued driving and educate drivers about how to recognize and deal with fatigue and sleepiness when they ultimately occur.

Work Stress and Early Atherosclerosis: Do Genetic Background and Pre-Employment Risk Factors Explain Conflicting Findings?

According to the models conceptualizing work stress, increased risk of health problems arise when high job demands co-occur with low job control (the demand-control model) or the efforts invested by the employee are disproportionately high compared to the rewards received (effort-reward imbalance model). This study examined the association between work stress and early atherosclerosis with particular attention to the role of pre-employment risk factors and genetic background in this association. The subjects were young healthy adults aged 24-39 who were participating in the 21-year follow-up of the ongoing prospective "Cardiovascular Risk in Young Finns" study in 2001-2002. Work stress was evaluated with questionnaires on demand-control model and on effort-reward model. Atherosclerosis was assessed with ultrasound of carotid artery intima-media thickness (IMT). In addition, risk for enhanced atherosclerotic process was assessed by measuring with heart rate variability and heart rate. Pre-employment risk factors, measured at age 12 to 18, included such as body mass index, blood lipids, family history of coronary heart disease, and parental socioeconomic position. Variants of the neuregulin-1 were determined using genomic DNA. The results showed that higher work stress was associated with higher IMT in men. This association was not attenuated by traditional risk factors of atherosclerosis and coronary heart disease or by pre-employment risk factors measured in adolescence. Neuregulin-1 gene moderated the association between work stress and IMT in men. A significant association between work stress and IMT was found only for the T/T genotype of the neuregulin-1 gene but not for other genotypes. Among women an association was found between higher work stress and lower heart rate variability, suggesting higher risk for developing atherosclerosis. These associations could not be explained by demographic characteristics or coronary risk factors. The present findings provide evidence for an association between work stress and atherosclerosis in relatively young population. This association seems to be modified by genetic influences but it does not appear to be confounded by pre-employment adolescent risk factors.

Coffee and risk of type 2 diabetes

Type 2 diabetes is one of the diseases that largely determined by lifestyle factors. Coffee is one of the most consumed beverages in the world and recently released data suggest the effects of coffee consumption on type 2 diabetes. The objective of the present study was to evaluate the effects of habitual coffee consumption on various aspects of type 2 diabetes and its most common complications. This study is part of the national FINRISK studies. Baseline surveys were carried out between 1972 and 1997. The surveys covered two eastern regions in 1972 and 1977, but were expanded to include a third region in southwestern Finland in 1982, 1987, 1992, and 1997. The Helsinki capital area was included in the survey in 1992 and 1997 and the Oulu province, in northern Finland, in 1997. Each survey was drawn from an independent random sample of the national register of subjects aged 25-64. In 1997, an additional sample of subjects aged 65-74 was conducted. The blood pressure, weight, and height of subjects were measured. By using self-administered questionnaires data were collected on medical history, socioeconomic factors, physical activity, smoking habits, and alcohol, coffee, and tea consumption. Higher coffee consumption was associated with higher body mass index, occupational physical activity and cigarette smoking, and lower blood pressure, education level, leisure time physical activity, tea consumption and alcohol use. Age, body mass index, systolic blood pressure and current smoking were positively associated with the risk of type 2 diabetes, however, education, and occupational, commuting and leisure time physical activity were inversely associated. The significant inverse association between coffee consumption and the risk of type 2 diabetes was found in both sexes but the association was stronger in women. Coffee consumption was significantly and inversely associated with fasting glucose, 2-hour plasma glucose, fasting insulin, impaired fasting glucose, impaired glucose regulation, and hyperinsulinemia among both men and women and with isolated impaired glucose tolerance among women. Serum gamma-glutamyltransferase modified the association between coffee consumption and incident diabetes. Among subjects with high serum -glutamyltransferase (>75th percentile), coffee consumption showed an inverse association for women, as well as men and women combined. An inverse association also occurred between coffee consumption and the risk of total, cardiovascular disease, and coronary heart disease mortality among patients with type 2 diabetes. The results of this study showed that habitual coffee consumption may be associated with a reduced risk of type 2 diabetes. Coffee consumption may have some effects on several markers of glycemia, and may lower the incident of type 2 diabetes in high normal serum -glutamyltransferase levels. Total, cardiovascular disease, and coronary heart disease mortality rate among subjects with type 2 diabetes may also be reduced by coffee consumption.

Pain among employees : risk factors and consequences

The overall objective of this study was to gain epidemiological knowledge about pain among employee populations. More specifically, the aims were to assess the prevalence of pain, to identify socio-economic risk groups and work-related psychosocial risk factors, and to assess the consequences in terms of health-related functioning and sickness absence. The study was carried out among the municipal employees of the City of Helsinki. Data comprised questionnaire survey conducted in years 2000-2002 and register data on sickness absence. Altogether 8960 40-60 year old employees participated to the survey (response rate 67%). Pain is common among ageing employees. Approximately 29 per cent of employees reported chronic pain and 15 per cent acute pain, and about seven per cent reported moderately or severely limiting disabling chronic pain. Pain was more common among those with lower level of education or in a low occupational class. -- Psychosocial work environment was associated with pain reports. Job strain, bullying at workplace, and problems in combining work and home duties were associated with pain among women. Among men combining work and home duties was not associated with pain, whereas organizational injustice showed associations. Pain affects functional capacity and predicts sickness absence. Those with pain reported lower level of both mental and physical functioning than those with no pain, physical functioning being more strongly affected than mental. Bodily location of pain or whether pain was acute or chronic had only minor impact on the variation in functioning, whereas the simple count of painful locations was associated with widest variation. Pain accounted for eight per cent of short term (1-3 day) sickness absence spells among men and 13 per cent among women. Of absence spells lasting between four and 14 days pain accounted for 23 per cent among women and 25 per cent among men, corresponding figures for over 14 day absence spells being 37 and 30 per cent. The association between pain and sickness absence was relatively independent of physical and psychosocial work factors, especially among women. The results of this study provide a picture of the epidemiology of pain among employees. Pain is a significant problem that seriously affects work ability. Information on risk groups can be utilized to make prevention measures more effective among those at high risk, and to decrease pain rates and thereby narrow the differences between socio-economic groups. Furthermore, the work-related psychosocial risk factors identified in this study are potentially modifiable, and it should be possible to target interventions on decreasing pain rates among employees.

Prevention of type 2 diabetes with lifestyle intervention - emphasis on dietary composition and identification of high-risk individuals

Type 2 diabetes is an increasing, serious, and costly public health problem. The increase in the prevalence of the disease can mainly be attributed to changing lifestyles leading to physical inactivity, overweight, and obesity. These lifestyle-related risk factors offer also a possibility for preventive interventions. Until recently, proper evidence regarding the prevention of type 2 diabetes has been virtually missing. To be cost-effective, intensive interventions to prevent type 2 diabetes should be directed to people at an increased risk of the disease. The aim of this series of studies was to investigate whether type 2 diabetes can be prevented by lifestyle intervention in high-risk individuals, and to develop a practical method to identify individuals who are at high risk of type 2 diabetes and would benefit from such an intervention. To study the effect of lifestyle intervention on diabetes risk, we recruited 522 volunteer, middle-aged (aged 40 - 64 at baseline), overweight (body mass index > 25 kg/m2) men (n = 172) and women (n = 350) with impaired glucose tolerance to the Diabetes Prevention Study (DPS). The participants were randomly allocated either to the intensive lifestyle intervention group or the control group. The control group received general dietary and exercise advice at baseline, and had annual physician's examination. The participants in the intervention group received, in addition, individualised dietary counselling by a nutritionist. They were also offered circuit-type resistance training sessions and were advised to increase overall physical activity. The intervention goals were to reduce body weight (5% or more reduction from baseline weight), limit dietary fat (< 30% of total energy consumed) and saturated fat (< 10% of total energy consumed), and to increase dietary fibre intake (15 g / 1000 kcal or more) and physical activity (≥ 30 minutes/day). Diabetes status was assessed annually by a repeated 75 g oral glucose tolerance testing. First analysis on end-points was completed after a mean follow-up of 3.2 years, and the intervention phase was terminated after a mean duration of 3.9 years. After that, the study participants continued to visit the study clinics for the annual examinations, for a mean of 3 years. The intervention group showed significantly greater improvement in each intervention goal. After 1 and 3 years, mean weight reductions were 4.5 and 3.5 kg in the intervention group and 1.0 kg and 0.9 kg in the control group. Cardiovascular risk factors improved more in the intervention group. After a mean follow-up of 3.2 years, the risk of diabetes was reduced by 58% in the intervention group compared with the control group. The reduction in the incidence of diabetes was directly associated with achieved lifestyle goals. Furthermore, those who consumed moderate-fat, high-fibre diet achieved the largest weight reduction and, even after adjustment for weight reduction, the lowest diabetes risk during the intervention period. After discontinuation of the counselling, the differences in lifestyle variables between the groups still remained favourable for the intervention group. During the post-intervention follow-up period of 3 years, the risk of diabetes was still 36% lower among the former intervention group participants, compared with the former control group participants. To develop a simple screening tool to identify individuals who are at high risk of type 2 diabetes, follow-up data of two population-based cohorts of 35-64 year old men and women was used. The National FINRISK Study 1987 cohort (model development data) included 4435 subjects, with 182 new drug-treated cases of diabetes identified during ten years, and the FINRISK Study 1992 cohort (model validation data) included 4615 subjects, with 67 new cases of drug-treated diabetes during five years, ascertained using the Social Insurance Institution's Drug register. Baseline age, body mass index, waist circumference, history of antihypertensive drug treatment and high blood glucose, physical activity and daily consumption of fruits, berries or vegetables were selected into the risk score as categorical variables. In the 1987 cohort the optimal cut-off point of the risk score identified 78% of those who got diabetes during the follow-up (= sensitivity of the test) and 77% of those who remained free of diabetes (= specificity of the test). In the 1992 cohort the risk score performed equally well. The final Finnish Diabetes Risk Score (FINDRISC) form includes, in addition to the predictors of the model, a question about family history of diabetes and the age category of over 64 years. When applied to the DPS population, the baseline FINDRISC value was associated with diabetes risk among the control group participants only, indicating that the intensive lifestyle intervention given to the intervention group participants abolished the diabetes risk associated with baseline risk factors. In conclusion, the intensive lifestyle intervention produced long-term beneficial changes in diet, physical activity, body weight, and cardiovascular risk factors, and reduced diabetes risk. Furthermore, the effects of the intervention were sustained after the intervention was discontinued. The FINDRISC proved to be a simple, fast, inexpensive, non-invasive, and reliable tool to identify individuals at high risk of type 2 diabetes. The use of FINDRISC to identify high-risk subjects, followed by lifestyle intervention, provides a feasible scheme in preventing type 2 diabetes, which could be implemented in the primary health care system.