Stock Options and Managerial Incentives to Invest

42 Pages Posted: 7 Aug 2001

See all articles by Tom Nohel

Tom Nohel

Loyola University of Chicago

Steven K. Todd

Loyola University of Chicago

Date Written: November 9, 2001

Abstract

We examine the effect of stock options on managerial incentives to invest. Our chief innovation is a model wherein firm value and executive decisions are endogenous. Numerical solutions to our model show that managerial incentives to invest are multi-dimensional and highly sensitive to option strike prices, the manager's wealth, degree of diversification, risk aversion, and career concerns. We find that over-investment problems are far more likely and far more severe than many researchers suggest. Finally, firm value is not a strictly increasing function of a manager's incentive compensation or conventional pay-for-performance metrics. Stronger managerial incentives to invest can benefit or harm a firm. Our results should send a cautionary signal to researchers who study managerial behavior. It is not sufficient to rely on one-dimensional risk-neutral valuation metrics, such as pay-for-performance, to describe the degree of incentive alignment between managers and shareholders.

JEL Classification: G31, G32, G34, J33, M40, M46

Suggested Citation

Nohel, Tom and Todd, Steven K., Stock Options and Managerial Incentives to Invest (November 9, 2001). EFMA 2002 London Meetings. Available at SSRN: https://ssrn.com/abstract=279212 or http://dx.doi.org/10.2139/ssrn.279212

Tom Nohel

Loyola University of Chicago ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States
312-915-7065 (Phone)
312-915-8508 (Fax)

Steven K. Todd (Contact Author)

Loyola University of Chicago ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States
(312) 915-7218 (Phone)
(312) 915-8508 (Fax)

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