Indexed Executive Stock Options

Posted: 4 Jan 2001

See all articles by Yisong S. Tian

Yisong S. Tian

York University - Schulich School of Business

Shane A. Johnson

Texas A&M University - Department of Finance

Abstract

We design and derive a pricing model for an executive stock option with a strike price indexed to a benchmark and investigate its valuation and incentive implications. In both up and down markets, the indexed option filters out common risks beyond the executive's control, thereby increasing the efficiency of incentive contracts. The indexed option has a different payoff structure and much lower initial value than a traditional option. Incentive effects of the indexed option also differ from those of traditional options. We design an optional penalty function to reduce the payoff if executives manipulate specified model parameters such as volatility.

Keywords: Executive stock options, Executive compensation, Option valuation, Indexed options

JEL Classification: J33, G13

Suggested Citation

Tian, Yisong Sam and Johnson, Shane A., Indexed Executive Stock Options. Journal of Financial Economics, Vol. 57, No. 1, July 2000. Available at SSRN: https://ssrn.com/abstract=251511

Yisong Sam Tian

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)

Shane A. Johnson (Contact Author)

Texas A&M University - Department of Finance ( email )

Mays School of Business
College Station, TX 77843-4218
United States
979-862-3318 (Phone)

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