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Stock Options for Undiversified ExecutivesBrian J. HallNOM Unit Head, Harvard Business School; National Bureau of Economic Research (NBER) Kevin J. MurphyUniversity of Southern California - Marshall School of Business; University of Southern California - Department of Economics; USC Gould School of Law November 2001 Harvard NOM Research Paper No. 00-05; Presented at Tuck-JFE Contemporary Corporate Governance Conference; USC FBE Working Paper No. 01-16 Abstract: We employ a certainty-equivalence framework to analyze the cost, value and pay/performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive "Executive Value" lines, the risk-adjusted analogues to Black-Scholes lines. We show that distinguishing between "executive value" and "company cost" provides insight into many issue regarding stock option practice including: executive views about Black-Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.
Number of Pages in PDF File: 55 Keywords: Executive Compensation, Incentives, Stock Options, Risk Aversion JEL Classification: J33, J44, G13, G32, M12 working papers seriesDate posted: December 14, 2000Suggested CitationContact Information
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