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CEO Option Sensitivity to Dividend Yield and Its Impact on Corporate Dividend Policy

We document a significantly negative correlation between the absolute sensitivity of the CEO’s option portfolio value to dividend yield (denoted by the Greek letter Psi) and corporate dividend payouts. After the implementation of the FAS 123R, firms that reduce the CEOs’ holdings of highly dividend-sensitive options increase dividends significantly. Furthermore, after the 2003 dividend tax cut, firms are much less likely to increase dividends if their CEOs’ option Psi is larger. The result is stronger for firms with less independent boards and when directors receive large amounts of option grants. These results support a causal impact of the CEO’s portfolio (dis)incentives on corporate dividend policy.