Estimating the Cost of Executive Stock Options: Evidence from Switzerland

31 Pages Posted: 14 Jun 2005

See all articles by Wolfgang Drobetz

Wolfgang Drobetz

Hamburg University

Pascal Pensa

University of Basel - Department of Finance

Markus Schmid

University of St. Gallen - Swiss Institute of Banking and Finance; University of St. Gallen - School of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

Abstract

It is often argued that Black-Scholes (1973) values overstate the subjective value of stock options granted to risk-averse and under-diversified executives. We construct a "representative" Swiss executive and extend the certainty-equivalence approach presented by Hall and Murphy (2002) to assess the value-cost wedge of executive stock options. Even with low coefficients of relative risk aversion, the discount can be above 50% compared to the Black-Scholes values. Regression analysis reveals that the equilibrium level of executive compensation is explained by economic determinant variables such as firm size and growth opportunities, whereas the managers' pay-for-performance sensitivity remains largely unexplained. Firms with larger boards of directors pay higher wages, indicating potentially unresolved agency conflicts. We reject the hypothesis that cross-sectional differences in the amount of executive pay vanish when risk-adjusted values are used as the dependent variable.

Keywords: Managerial compensation, incentives, executive stock options, option valuation, risk aversion

JEL Classification: J33, G13, G32

Suggested Citation

Drobetz, Wolfgang and Pensa, Pascal and Schmid, Markus, Estimating the Cost of Executive Stock Options: Evidence from Switzerland (March 2007). Available at SSRN: https://ssrn.com/abstract=743045 or http://dx.doi.org/10.2139/ssrn.743045

Wolfgang Drobetz

Hamburg University ( email )

Moorweidenstrasse 18
Hamburg, 20148
Germany

Pascal Pensa (Contact Author)

University of Basel - Department of Finance ( email )

Holbeinstrasse 12
Basel, CH-4051
Switzerland
+41612673318 (Phone)
+41612670898 (Fax)

HOME PAGE: http://www.wwz.unibas.ch/finance/team/pensa/

Markus Schmid

University of St. Gallen - Swiss Institute of Banking and Finance ( email )

Rosenbergstrasse 52
St. Gallen, 9000
Switzerland

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

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