Estimating the Cost of Executive Stock Options: Evidence from Switzerland

18 Pages Posted: 1 Oct 2007

See all articles by Wolfgang Drobetz

Wolfgang Drobetz

University of Hamburg

Pascal Pensa

University of Basel - Department of Finance

Markus Schmid

University of St. Gallen - Swiss Institute of Banking and Finance; University of St. Gallen - School of Finance

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Abstract

It is often argued that Black-Scholes (1973) values overstate the subjective value of stock options granted to risk-averse and under-diversified executives. We construct a "representative" Swiss executive and extend the certainty-equivalence approach presented by Hall and Murphy (2002) to assess the value-cost wedge of executive stock options. Even with low coefficients of relative risk aversion, the discount can be above 50 per cent compared to the Black-Scholes values. Regression analysis reveals that the equilibrium level of executive compensation is explained by economic determinant variables such as firm size and growth opportunities, whereas the pay-for-performance sensitivity remains largely unexplained. Firms with larger boards of directors pay higher wages, indicating potentially unresolved agency conflicts. We reject the hypothesis that cross-sectional differences in the amount of executive pay vanish when risk-adjusted values are used as the dependent variable.

Suggested Citation

Drobetz, Wolfgang and Pensa, Pascal and Schmid, Markus, Estimating the Cost of Executive Stock Options: Evidence from Switzerland. Corporate Governance: An International Review, Vol. 15, No. 5, pp. 798-815, September 2007. Available at SSRN: https://ssrn.com/abstract=1017397 or http://dx.doi.org/10.1111/j.1467-8683.2007.00612.x

Wolfgang Drobetz (Contact Author)

University of Hamburg ( email )

Moorweidenstrasse 18
Hamburg, 20148
Germany

Pascal Pensa

University of Basel - Department of Finance ( email )

Holbeinstrasse 12
Basel, CH-4051
Switzerland
+41612673318 (Phone)
+41612670898 (Fax)

HOME PAGE: http://www.wwz.unibas.ch/finance/team/pensa/

Markus Schmid

University of St. Gallen - Swiss Institute of Banking and Finance ( email )

Rosenbergstrasse 52
St. Gallen, 9000
Switzerland

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

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