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Are Executive Stock Options Associated with Future Earnings?

61 Pages Posted: 6 Jan 2004  

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Shivaram Rajgopal

Columbia Business School

Terry J. Shevlin

University of California-Irvine

Date Written: December 20, 2002

Abstract

We estimate the relation between top 5 executive stock option (ESO) grants and future earnings to examine whether incentive alignment or rent extraction by top managers explains option granting behavior. The future operating income associated with a dollar of Black-Scholes value of an ESO grant is $3.82. To understand the source of these positive payoffs, we parse out ESO grant value into components predicted by economic determinants of option grants, governance quality, and a residual grant value. The payoffs to ESOs appear to be driven predominantly by the economic determinants of ESO grants and not poor governance quality. Thus we find little evidence in support of rent extraction.

Keywords: management compensation, stock options, incentive alignment, rent extraction

JEL Classification: G30, J33, M41

Suggested Citation

Hanlon, Michelle and Rajgopal, Shivaram and Shevlin, Terry J., Are Executive Stock Options Associated with Future Earnings? (December 20, 2002). JAE Boston Conference October 2002. Available at SSRN: https://ssrn.com/abstract=318101 or http://dx.doi.org/10.2139/ssrn.318101

Michelle Hanlon (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-668
Cambridge, MA 02142
United States
617-253-9849 (Phone)

Shivaram Rajgopal

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

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