Ironing Out the Wrinkles in Executive Compensation: Linking Incentive Pay to Average Stock Prices

56 Pages Posted: 18 Feb 2012 Last revised: 20 Feb 2012

See all articles by Yisong S. Tian

Yisong S. Tian

York University - Schulich School of Business

Date Written: November 12, 2011

Abstract

Traditional stock option grant is the most common form of incentive pay in executive compensation. Applying a principal-agent analysis, we find this common practice suboptimal and firms are better off linking incentive pay to average stock prices. Holding the cost of the option grant to the firm constant, Asian stock options are more cost effective than traditional stock options and provide stronger incentives to increase stock price. More importantly, the improvement is achieved with little impact on the option grant’s risk incentives (after adjusting for option cost). Finally, averaging also improves the value and incentive effects of indexed stock options.

Keywords: Executive compensation, Optimal contracting, Executive stock options, Cost effectiveness, Incentive effects, Asian stock options, Indexed stock options

JEL Classification: G13, G30, J33, M52

Suggested Citation

Tian, Yisong Sam, Ironing Out the Wrinkles in Executive Compensation: Linking Incentive Pay to Average Stock Prices (November 12, 2011). Available at SSRN: https://ssrn.com/abstract=2007173 or http://dx.doi.org/10.2139/ssrn.2007173

Yisong Sam Tian (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada
416-736-2100, ext 77943 (Phone)
416-736-5687 (Fax)

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