Executive Equity Divestitures and Equity Granting Patterns

This paper empirically investigates the influence of executive wealth diversification on firm equity granting patterns. Theory suggests that undiversified, risk-averse executives discount the value of their equity holdings in the firm, which reduce the incentives provided by equity grants. When executives divest equity from the firm, they insulate their wealth from firm-specific risk, increasing the incentives of equity grants. I find that equilibrium equity incentives and the incentives targeted by new equity grants are negatively related to increases in executive wealth diversification that result from equity divestitures. Overall, the evidence suggests that firms target risk-adjusted equity incentives and that the cost of achieving the target is negatively related with executive wealth diversification. The results are consistent with agency theory predictions of optimal contracting with undiversified, risk-averse managers.