What Determines Stock Option Contract Design?

42 Pages Posted: 18 Jan 2010 Last revised: 4 Apr 2011

See all articles by Eva Liljeblom

Eva Liljeblom

Swedish School of Economics and Business Administration

Daniel Pasternack

Hanken School of Economics; Eufex Ltd

Matts Rosenberg

IK Investment Partners

Date Written: January 14, 2010

Abstract

We analyze factors driving exercise price policy for executive option plans (ESOPs), and their scope, in a country where firms are not subject to such tax and accounting considerations, that have seemed to led to a dominance of at-the-money options in the U.S. Our “unbounded” data for Finland provides us with an excellent opportunity to investigate whether contract design is consistent with compensation theory. Our findings are largely consistent with predictions from the optimal contracting literature. The size of the plan is negatively related to Tobin’s Q and firm size, and positively related to proxies for monitoring costs, which also explain the probability for launching premium ESOPs. However, our results also show that the premium (out-of-the-moneyness) is negatively related to prior stock return and cash flow to assets, which may indicate higher managerial powers, leading to more in-the-money options, in well-performing firms. Finally, we also report a positive relationship between the premium and the length of the vesting period, indicating an effort to keep the incentives for the management from falling over time.

Keywords: Stock option contract design, Optimal contracting, Agency costs

JEL Classification: G30, G32, J33

Suggested Citation

Liljeblom, Eva and Pasternack, Daniel and Rosenberg, Matts, What Determines Stock Option Contract Design? (January 14, 2010). Available at SSRN: https://ssrn.com/abstract=1537022 or http://dx.doi.org/10.2139/ssrn.1537022

Eva Liljeblom

Swedish School of Economics and Business Administration ( email )

P.O. Box 479
FI-00101 Helsinki, 00101
Finland
+358-9-431 33 291 (Phone)
+358-9-431 33 393 (Fax)

Daniel Pasternack (Contact Author)

Hanken School of Economics ( email )

P.O. Box 479
FI-00101 Helsinki, 00101
Finland

Eufex Ltd ( email )

Keilaranta 19
Espoo, 02150
Finland

Matts Rosenberg

IK Investment Partners ( email )

Birger Jarlsgatan 4
Stockholm, 11434
Sweden

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
277
Abstract Views
1,833
rank
129,335
PlumX Metrics