Stock Options for Undiversified Executives
Brian J. Hall
NOM Unit Head, Harvard Business School; National Bureau of Economic Research (NBER)
Kevin J. Murphy
University of Southern California - Marshall School of Business; University of Southern California - Department of Economics; USC Gould School of Law
Journal of Accounting & Economics, Vol. 33, No. 2, April 2002
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 analogs 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.
Keywords: executive compensation, incentives, stock options, risk aversion
JEL Classification: J33, J44, G13, G32, M12Accepted Paper Series
Date posted: April 30, 2002
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