Stock Options for Undiversified Executives

51 Pages Posted: 7 Mar 2001 Last revised: 20 Oct 2010

See all articles by Brian J. Hall

Brian J. Hall

NOM Unit Head, Harvard Business School; National Bureau of Economic Research (NBER)

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

Multiple version iconThere are 3 versions of this paper

Date Written: December 2000

Abstract

We employ a certainty-equivalence framework to analyze the cost and value of, and pay/performance incentives provided by, non-tradable options held by undiversified, risk-averse executives. We derive Executive Value' lines, the risk-adjusted analogues to Black-Scholes lines, and distinguish between executive value' and company cost.' We demonstrate that the divergence between the value and cost of options explains, or provides insight into, virtually every major issue regarding stock option practice including: executive views about Black-Scholes measures of options; tradeoffs between options, stock and cash; exercise price policies; connections between the pay-setting process and exercise price policies; institutional investor views regarding options and restricted stock; 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.

Suggested Citation

Hall, Brian and Murphy, Kevin J., Stock Options for Undiversified Executives (December 2000). NBER Working Paper No. w8052. Available at SSRN: https://ssrn.com/abstract=254013

Brian Hall (Contact Author)

NOM Unit Head, Harvard Business School ( email )

Soldiers Field
Boston, MA 02163
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617-495-5062 (Phone)
617-496-4191 (Fax)

HOME PAGE: http://www.people.hbs.edu/bhall/

National Bureau of Economic Research (NBER)

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Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

BRI 308, MC 0804
Los Angeles, CA 90089-0804
United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States

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