Executive Stock Options: Early Exercise Provisions and Risk-Taking Incentives

Abstract

Traditional executive stock option plans allow fixed numbers of options to vest periodically, independent of stock price performance. Because such options may climb deep in-the-money long before the manager can exercise them, they can exacerbate risk aversion in project selection. Making the proportion of options that vest a gradually increasing function of the stock price can ensure that appropriate numbers of options are retained while they provide risk-taking incentives, but are exercised once they have lost their convexity. Progressive performance vesting can allow the firm more efficiently to rebalance the manager's risk-taking incentives.

Keywords: Executive compensation, stock options, vesting, early exercise, corporate investment decisions, risk taking

JEL Classification: G31, J33