Options, Option Repricing and Severance Packages in Managerial Compensation: Their Effects on Corporate Risk

35 Pages Posted: 6 Apr 2003

See all articles by Nengjiu Ju

Nengjiu Ju

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Hayne E. Leland

University of California, Berkeley - Walter A. Haas School of Business

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Date Written: December 2002

Abstract

While stock options are commonly used in managerial compensation to provide desirable incentives, their adverse effects have not been widely appreciated. We show that a call-type contract creates incentives to distort the choice of investment risk. Relative to the risk level that maximizes firm value, a call option contract can induce too much or too little corporate risk-taking, depending on managerial risk aversion and the underlying investment technology. We show that including additional compensation features of option repricing and/or severance packages has desirable countervailing effects on managerial choice of corporate risk policies. We argue that lookback call options are analogous to the observed practice of option repricing, and put options are analogous to severance packages. Such complex option-like features in managerial contracts can induce risk policies that increase shareholder wealth.

Keywords: Managerial compensation, option repricing and severance packages, managerial incentives

JEL Classification: G3

Suggested Citation

Ju, Nengjiu and Leland, Hayne E. and Senbet, Lemma W., Options, Option Repricing and Severance Packages in Managerial Compensation: Their Effects on Corporate Risk (December 2002). Available at SSRN: https://ssrn.com/abstract=346920 or http://dx.doi.org/10.2139/ssrn.346920

Nengjiu Ju (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Hayne E. Leland

University of California, Berkeley - Walter A. Haas School of Business ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
(510) 642-8694 (Phone)
(510) 643-1420 (Fax)

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

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