Can CEO equity-based compensation limit investment-related agency problems?

Previous research suggests that investment-cash flow sensitivity (ICS) has arisen from agency costs. This study investigates whether equity-based compensation (EBC) reduces these costs. We find that ICS is lower when companies grant EBC to chief executive officers (CEOs). EBC with long-term vesting periods, and especially with graded vesting conditions, is associated with a lower ICS. EBC with performance hurdles is associated with higher sensitivity. However, when the performance hurdles are set as a relative market index rather than an absolute target, the sensitivity becomes lower. Our results suggest that appropriately designed EBC plays an important role in mitigating investment-related agency problems.