Opinion: Options markets reveal true significance of AGMs
A central question in corporate finance is how to ensure management acts in the best interest of shareholders. Shareholder meetings play an essential role in keeping management accountable, ensuring greater transparency and bringing shareholders into decisions. From electing members to the board to approving new securities or payment of dividends, important proposals are often voted on at these annual meetings.
One would expect, as such, that the markets would react to the outcomes of these proposals in a positive or negative way when the voting results are announced. If the news is perceived as positive overall, one would assume the market reaction should be positive. And if the news is perceived as negative overall, the market reaction should be negative.
Shareholder meetings involve events with important voting outcomes, yet existing research on stock market reactions to votes on these proposals have not uncovered a strong relationship to the apparent stock market reaction to them. We were intrigued by this puzzle and wondered whether markets truly don’t find these proposals to be important or whether there may be a different story.
We sought to better understand this relationship in our research paper, Shareholder meetings matter: Evidence from the options market.
In particular, we conjectured whether there is a ‘canceling out effect’ that may make it appear as though investors are indifferent to meeting outcomes, when in fact they care about the voting results. Most meetings have multiple proposals. Some increase company value and some decrease it. So if both positive and negative things happen simultaneously, a canceling out of a positive and negative reaction could be interpreted as no equity market reaction as a result.
We decided to look to the options market and its ability to capture possible future price changes in both directions. Looking at options, and in particular implied volatility (IV), enables us to capture both positive and negative reactions, because IV is related to the price movement in either direction.
IV measures the market’s anticipated likelihood of changes in a security’s price in the future. While IVs tend to stay pretty close to historical levels, they do tend to deviate around important corporate events. For example, research in the past has shown that IV drops sharply after quarterly earnings are announced, because uncertainty is then resolved. Looking at IVs allowed us to capture investor perception of possible stock price changes around annual shareholder meetings, regardless of whether they are positive or negative.
We conjectured that if investors in the market worry about the influence of a proposal on a given firm, this will be reflected in the options prices of the underlying stock. To examine this, we used OptionMetrics data, considered the gold standard for options research and recognized for its high quality and data organization. We merged OptionMetrics data with information on shareholder proposals and meetings, among other things.
We examined perceptions of shareholders on the underlying stocks for companies holding annual shareholder meetings during several time periods. In particular, we looked at the period around the meeting dates and also from record date (or the date used to determine which shareholders can vote on proposals) to shareholder meeting dates, and after these dates. We analyzed standardized 30-day options from OptionMetrics for our main analysis to ensure consistency in the window of analysis to avoid IV changing as options get closer to maturity. We examined standardized IV at the straddle level, by averaging call and put IVs, dropping some of the outliers in case there are large differences between calls and puts, to address concerns on stale option prices.
Our main finding is that IV gradually declines several months prior to the meetings up to the meeting date, from the record date to the date of the meeting. In particular, we find that right before and right after the annual shareholder meeting when voting outcomes are announced, there is not a lot of change in IV. But from the record date to the date of the shareholder meeting, there is a big change. IV is 1.04 percentage points higher on the shareholder record versus shareholder meeting date. IV then declines from this date. We also witnessed another 0.3 percentage-point decline in IV right around the meeting date. We attribute this to information on the proposals slowly getting out to the market, from them being voted on to voting counts via mail becoming disclosed, and so on.
We also looked more deeply at the IV of shareholder meetings by the goal in the shareholder meeting. In particular, we looked at meetings with shareholder proposals versus those without them. We noticed that there is not much of a difference in IV in the short term between these. Yet when we look at meetings with close votes – within 5 percent to 10 percent margins – our results imply that close-call shareholder proposals have a significant effect on company value regardless of the voting outcome (pass or fail). By contrast, it is the failure of close-call management proposals that tend to offer a surprising outcome to the market, resulting in an options market reaction. We also provide analysis based on specific proposals: say on pay, director elections, board declassification and other governance proposals, ESG/CSR and political disclosure proposals.
Our main finding across all meetings is that investors constantly update their expectations on meeting outcomes based on information on the proposals slowly getting out to the market. This can be from proxy advisory firms indicating voting recommendations on proposals – as early as several weeks before the annual shareholder meeting – that mutual funds and others tend to follow, markets learning how shareholders are voting and other factors. The result is a gradual update of investor expectations as information is released.
We find that shareholder meetings are indeed important – but investors update their expectations over a very long period of time, up to several months. Hence, if you look at the short-term window, such as with the stock market, you likely won’t be able to capture the reaction in the market. Instead, one should look several months leading up to the meeting in the options market. That is when you can start to capture the importance of the shareholder meetings.
What should investors take from the research? We offer four key points:
- Option event studies around corporate events provide useful information above and beyond regular equity stock price event studies
- Shareholder meetings are not a sideshow. Shareholder meeting proposals do matter. Some proposals increase company value, while others decrease it. But one needs to look outside of equity markets – for example, to the options markets – to see the results
- Additionally, some events such as shareholder meetings need to be examined over a longer timeframe, not just around the meeting, but also some of the events leading up to it
- Record dates, as the time where IV tends to be highest prior to the meeting, appear to be important, and likely more regulatory disclosure is needed around these dates
- There is a gradual release of information related to shareholder meetings as the market updates information related to their outcomes over time. Previous studies show information diffuses gradually, but there has not been a systematic documentation up until now.
Companies take shareholder meetings very seriously. And there is a good reason for that. If you only look at the equity market reaction to proposals at shareholder meetings, you may be puzzled by the appearance that the market is not treating this as an important event when it is important to the company. But our evidence shows that the market does indeed think this is an important event and corporations are doing the right thing in paying attention to it.
Kateryna Holland is an assistant professor of finance at the University of Missouri. Chan Lim is a PhD candidate in finance at Purdue University. Irene Yi is an assistant professor of finance at the University of Toronto. You can read their full research on this topic at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3765575