Stock Options and Managers' Incentives to Cheat

46 Pages Posted: 20 Jan 2005

See all articles by Marc Chesney

Marc Chesney

University of Zurich - Department of Banking and Finance

Rajna Gibson

University of Geneva - Geneva Finance Research Institute (GFRI)

Date Written: January 11, 2005

Abstract

In this paper, we use a continuous-time contingent claims framework to study managers' incentives to cheat in the presence of equity-based compensation policies. When we consider a fully predictable legal process, we observe that managers will always have incentives to engage in illicit activities. The exercise of the option to cheat will be postponed if the corruption costs or if the manager's reputational loss increases. We further show that managers incentives to cheat are delayed and can even be eliminated when the legal settlement date is non-predictable. An important result is that managers will always cheat sooner with stock options than with a cash equivalent remuneration consisting of stocks. Finally, we propose a new remuneration package that consists of both long calls and short puts written on the firm's stocks in order to reduce managers incentives to cheat.

Keywords: Executive compensation, fraud, incentives, stock options

JEL Classification: G13, G30

Suggested Citation

Chesney, Marc and Gibson, Rajna, Stock Options and Managers' Incentives to Cheat (January 11, 2005). Available at SSRN: https://ssrn.com/abstract=651207 or http://dx.doi.org/10.2139/ssrn.651207

Marc Chesney (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

HOME PAGE: http://https://www.bf.uzh.ch/en/persons/chesney-marc

Rajna Gibson

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland
+41.22.379.89.83 (Phone)

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