55 Pages Posted: 14 Dec 2000
Date Written: November 2001
We employ a certainty-equivalence framework to analyze the cost, value and pay/performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive "Executive Value" lines, the risk-adjusted analogues to Black-Scholes lines. We show that distinguishing between "executive value" and "company cost" provides insight into many issue regarding stock option practice including: executive views about Black-Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.
Keywords: Executive Compensation, Incentives, Stock Options, Risk Aversion
JEL Classification: J33, J44, G13, G32, M12
Suggested Citation: Suggested Citation
Hall, Brian J. and Murphy, Kevin J., Stock Options for Undiversified Executives (November 2001). Harvard NOM Research Paper No. 00-05; Presented at Tuck-JFE Contemporary Corporate Governance Conference; USC FBE Working Paper No. 01-16. Available at SSRN: https://ssrn.com/abstract=252805 or http://dx.doi.org/10.2139/ssrn.252805
By Kevin Murphy