Are Executive Stock Options Associated with Future Earnings?
Massachusetts Institute of Technology (MIT) - Sloan School of Management
Emory University - Goizueta Business School
Terry J. Shevlin
University of California-Irvine
December 20, 2002
JAE Boston Conference October 2002
We estimate the relation between top 5 executive stock option (ESO) grants and future earnings to examine whether incentive alignment or rent extraction by top managers explains option granting behavior. The future operating income associated with a dollar of Black-Scholes value of an ESO grant is $3.82. To understand the source of these positive payoffs, we parse out ESO grant value into components predicted by economic determinants of option grants, governance quality, and a residual grant value. The payoffs to ESOs appear to be driven predominantly by the economic determinants of ESO grants and not poor governance quality. Thus we find little evidence in support of rent extraction.
Number of Pages in PDF File: 61
Keywords: management compensation, stock options, incentive alignment, rent extraction
JEL Classification: G30, J33, M41
Date posted: January 6, 2004
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