Enhancing Managerial Equity Incentives with Moving Average Payoffs

Abstract

Prior research suggests that Asian stock options provide stronger managerial equity incentives than traditional stock options do, holding the cost of the option grant constant. Although this is true on the grant date, it is not over the life of the option grant. Very little of the initial advantage remains after two years because Asian stock options have diminishing incentive effects over time. A simple solution is to replace averaging over the option’s life with averaging over a moving window. We show that moving average options do not have the diminishing incentive problem and are effective in preventing managerial gaming.

Keywords: Managerial equity incentives, Executive stock options, Moving average, Asian stock options, Managerial gaming, Stock price manipulation

JEL Classification: G13, G30, J33