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The Diffusion of Equity Incentive Plans in Italian Listed Companies
1.INTRODUCTION
Past studies have brought to light the dissimilarities in the pay packages of managers in Anglo—Saxon countries as compared with other nations (e。g., Bebchuk, Fried and Walker， 2002; Cheffins and Thomas， 2004； Zattoni， 2007）。 In the UK and, above all in the US， remuneration encompasses a variety of components, and short and long term variable pay carries more weight than elsewhere (Conyon and Murphy， 2000)。 In other countries， however， fixed wages have always been the main ingredient in top managers' pay schemes。 Over time， variable short-term pay has become more substantial and the impact of fringe benefits has gradually grown。 Notwithstanding， incentives linked to reaching medium to long—term company goals have never been widely used (Towers Perrin， 2000）。
In recent years， however, pay packages of managers have undergone an appreciable change as variable pay has increased considerably, even outside the US and the UK. In particular, managers in most countries have experienced an increase in the variable pay related to long-term goals. Within the context of this general trend toward medium and long-term incentives, there is a pronounced tendency to adopt plans involving stocks or stock options （Towers Perrin， 2000； 2005). The drivers of the diffusion of long term incentive plans seem to be some recent changes in the institutional and market environment at the local and global levels。 Particularly important triggers of the convergence toward the US pay paradigm are both market oriented drivers, such as the evolving share ownership patterns or the internationalization of the labor market, and law—oriented drivers, such as corporate or tax regulation (Cheffins and Thomas， 2004)。 Driven by these changes in the institutional and market environment， we observe a global trend toward the “Americanization of international pay practices,” characterized by high incentives and very lucrative compensation mechanisms (e。g。， Cheffins, 2003; Cheffins and Thomas, 2004).
Ironically, the spread of the US pay paradigm around the world happens when it is hotly debated at home. In particular， the critics are concerned with both the level of executive compensation packages and the use of equity incentive plans (Cheffins and Thomas， 2004). Critics stressed that US top managers, and particularly the CEOs， receive very lucrative compensation packages。 The ’80s and ’90s saw an increasing disparity between CEO’s pay and that of rank—and—file workers. Thanks to this effect, their direct compensation has become a hundred times that of an average employee (Hall and Liebman， 1998). The main determinants of the increasing level of CEOs’ and executives’ compensation are annual bonuses and， above all, stock option grants （Conyon and Murphy， 2000）。 Stock option plans have recently been criticized by scholars and public opinion because they characteristically are too generous and symptomatic of a managerial extraction of the firm's value (Bebchuk et al.， 2002； Bebchuk and Fried， 2006）.
In light of these recent events and of the increased tendency to adopt equity incentive plans， this paper aims at understanding the reasons behind the dissemination of stock option and stock granting plans outside the US and the UK。 The choice to investigate this phenomenon in Italy relies on the following arguments。 First， the large majority of previous studies analyze the evolution of executive compensation and equity incentive plans in the US and, to a smaller extent， in the UK。 Second, ownership structure and governance practices in continental European countries are substantially different from the ones in Anglo-Saxon countries. Third, continental European countries， and Italy in particular， almost ignored the use of these instruments until the end of the ’90s.
Our goal is to compare the explanatory power of three competing views on the diffusion of equity incentive plans: 1） the optimal contracting view, which states that compensation packages are designed to minimize agency costs between managers and shareholders (Jensen and Murphy, 1990）； 2） the rent extraction view， which states that powerful insiders may influence the pay process for their own benefit (Bebchuk et al。, 2002)； and 3) the perceived—cost view (Hall and Murphy， 2003）， which states that companies may favor some compensation schemes for their （supposed or real)cost advantages.
To this purpose, we conducted an empirical study on the reasons why Italian listed companies adopted equity incentive plans since the end of the ’90s。 To gain a deep understanding of the phenomenon， we collected data and information both on the evolution of the national institutional environment in the last decade and on the diffusion and the characteristics （i.e。， technical aspects and objectives) of equity incentive plans adopted by Italian listed companies in 1999 and 2005. We used both logit models and difference-of—means statistical techniques to analyze data. Our results show that： 1） firm size, and not its ownership structure, is a determinant of the adoption of these instruments; 2) these plans are not extensively used to extract company value, although a few cases suggest this possibility； and 3) plans’ characteristics are consistent with the ones defined by tax law to receive special fiscal treatment。
Our findings contribute to the development of the literature on both the rationales behind the spreading of equity incentive schemes and the diffusion of new governance practices。 They show， in fact, that equity incentive plans have been primarily adopted to take advantage of large tax benefits， and that in some occasions they may have been used by controlling shareholders to extract company value at the expense of minority shareholders. In other words, our findings suggest that Italian listed companies adopted equity incentive plans to perform a subtle form of decoupling。 On the one hand, they declared that plans were aimed to align shareholders’ and managers’ interests and incentive value creation. On the other hand， thanks to the lack of transparency and previous knowledge about these instruments, companies used these mechanisms to take advantage of tax benefits and sometimes also to distribute a large amount of value to some powerful individuals. These results support a symbolic perspective on corporate governance， according to which the introduction of equity incentive plans please stakeholders – for their implicit alignment of interests and incentive to value creation – without implying a substantive improvement of governance practices。
2。Corporate Governance in Italian Listed Companies
Italian companies are traditionally controlled by a large blockholder （Zattoni, 1999）. Banks and other financial institutions do not own large shareholdings and do not exert a significant influence on governance of large companies, at least as far as they are able to repay their financial debt （Bianchi， Bianco and Enriques, 2001)。 Institutional investors usually play a marginal role because of their limited shareholding, their strict connections with Italian banks， and a regulatory environment that does not offer incentives for their activism. Finally， the stock market is relatively small and undeveloped， and the market for corporate control is almost absent （Bianco, 2001). In short， the Italian governance system can be described as a system of “weak managers, strong blockholders, and unprotected minority shareholders” （Melis， 2000: 354）.
The board of directors is traditionally one tier, but a shareholders’ general meeting must appoint also a board of statutory auditors as well whose main task is to monitor the directors’ performance (Melis, 2000). Further, some studies published in the ’90s showed that the board of directors was under the relevant influence of large blockholders。 Both inside and outside directors were in fact related to controlling shareholders by family or business ties （Melis， 1999;2000； Molteni, 1997).
Consistent with this picture， fixed wages have been the main ingredient of top managers’ remuneration， and incentive schemes linked to reaching medium to long term company goals have never been widely used (Melis， 1999）. Equity incentive schemes adopted by Italian companies issue stocks to all employees unconditionally for the purpose of improving the company atmosphere and stabilizing the share value on the Stock Exchange。 Only very few can be compared with stock option plans in the true sense of the term。 Even in this case, however， directors and top managers were rarely evaluated through stock returns, because of the supposed limited ability of the Italian stock market to measure firm’s performance （Melis, 1999）.
3。The Evolution of Italian Institutional Context
The institutional context in Italy has evolved radically in the last decade， creating the possibility for the dissemination of equity incentive plans. The main changes regarded the development of commercial law, the introduction and updating of the code of good governance， the issue of some reports encouraging the use of equity incentive plans， and the evolution of the tax law （Zattoni, 2006).
Concerning the national law and regulations， some reforms in the commercial law (1998, 2003， and 2005) and the introduction (1999) and update (2002) of the national code of good governance contributed to the improvement of the corporate governance of listed companies (Zattoni， 2006）. Financial markets and corporate law reforms improved the efficiency of the Stock Exchange and created an institutional environment more favorable to institutional investors’ activism （Bianchi and Enriques, 2005)。 At the same time the introduction and update of the code of good governance contributed to the improvement of governance practices at the board level. These reforms did not produce an immediate effect on governance practices of Italian listed companies, although they contributed to improve， slowly and with some delay, their governance standards （Zattoni, 2006）.
Beyond the evolution of governance practices, some changes in the institutional environment directly affected the diffusion and the characteristics of equity incentive plans。 Both the white paper of the Ministry of the Industry and Foreign Commerce and the code of good governance issued by the national Stock Exchange invited companies to implement equity incentive plans in order to develop a value creation culture in Italian companies. Furthermore， in 1997 fiscal regulations were enacted allowing a tax exemption on the shares received through an equity incentive plan. According to the new regulation， which took effect on January 1， 1998, issuance of new stocks to employees by an employer or another company belonging to the same group did not represent compensation in kind for income tax purposes （Autuori 2001）. In the following years, the evolution of tax rules reduced the generous benefits associated with the use of equity incentive plans， but also the new rules continued to favor the dissemination of these plans.
Driven by these changes in the institutional context， equity incentive plans became widely diffused among Italian listed companies at the end of the '90s (Zattoni, 2006）。 Ironically， the diffusion of these instruments – in Italy and in other countries, such as Germany （Bernhardt， 1999）， Spain (Alvarez Perez and Neira Fontela, 2005), and Japan (Nagaoka, 2005） – took place when they were strongly debated in the US for their unpredicted consequences and the malpractices associated with their use （Bebchuk et al。, 2002)。
4.The Rationales Explaining the Adoption of Equity Incentive Plans
Equity incentive plans are a main component of executive compensation in the US。 Their use is mostly founded on the argument that they give managers an incentive to act in the shareholders' interests by providing a direct link between their compensation and firm stock—price performance (Jensen and Murphy， 1990)。 Beyond that， equity incentive plans also have other positive features， as they may contribute to the attraction and retention of highly motivated employees, encourage beneficiaries to take risks, and reduce direct cash expenses for executive compensation （Hall and Murphy, 2003).
Despite all their positive features, the use of equity incentive plans is increasingly debated in the US。 In particular， critics question their presumed effectiveness in guaranteeing the alignment of executives’ and shareholders’ interests. They point out that these instruments may be adopted to fulfill other objectives， such as to extract value at shareholders expenses (e。g., Bebchuk and Fried, 2006)， or even to achieve a （real or perceived) reduction in compensation costs (e。g., Murphy, 2002). In summary， the actual debate indicates that three different rationales may explain the dissemination and the specific features of equity incentive plans：1) the optimal contracting view (Jensen and Murphy,1990 )；2) the rent extraction view （Bebchuk et al., 2002)； and 3）the perceived—cost view (Hall and Murphy, 2003).
According to the optimal contracting view， executive compensation packages are designed to minimize agency costs between top managers （agents) and shareholders (principals） (Jensen and Meckling, 1976）. The boards of directors are effective governance mechanisms aimed at maximizing shareholder value and the top management's compensation scheme is designed to serve this objective (Fama and Jensen， 1983)。 Providing managers with equity incentive plans may mitigate managerial self-interest by aligning the interests of managers and shareholders (Jensen and Meckling, 1976）. Following the alignment rationale, equity incentives may improve firm performance， as managers are supposed to work for their own and shareholders' benefit (Jensen and Murphy， 1990）. In short， these instruments are designed to align the interests of managers with those of shareholders， and to motivate the former to pursue the creation of share value （Jensen and Murphy, 1990)。
4。1 the principle of equity incentive
Managers and shareholders is a delegate agency relationship managers operating in assets under management， shareholders entrusted。 But in fact, in the agency relationship, the contract between the asymmetric information, shareholders and managers are not completely dependent on the manager's moral self-discipline. The pursuit of the goals of shareholders and managers is inconsistent. Shareholders want to maximize the equity value of its holdings of managers who want to maximize their own utility， so the ”moral hazard” exists between the shareholders and managers, through incentive and restraint mechanisms to guide and limit the behavior of managers.
In a different way of incentives, wages based on the manager’s qualification conditions and company, the target performance of a predetermined relatively stable in a certain period of time, a very close r