We investigate a link between agency costs and equity mispricing. We employ comprehensive, multi-dimensional measures of agency costs and mispricing, and find that mispricing is significantly and positively related with agency costs. We also explore the effect of equity-based compensation on the impact of agency costs on mispricing. Our investigation extends previous studies that do not separately account for the options and restricted stock grants components of equity-based compensation. We show that stock options, originally intended to resolve conflicts of interest, exaggerate the problem and this phenomenon is pronounced especially when firms are overvalued. Overall, our results imply that compensation packages that are not structured optimally could lead to greater mispricing.
JEL classification: G12; G14; M52
Keywords: Agency costs; Equity-based compensation; Equity mispricing
