To Buy or Not to Buy?: The Effect of Option Granting on Executive Stock Purchases

Abstract

Traditional portfolio diversification arguments suggest that if executives are granted options then they should hold less company stock than they would otherwise have done, diluting the incentive effects. There is little evidence, however, that companies do anything to prevent this and the anecdotal evidence does not seem to accord with traditional diversification arguments. We provide a model analyzing the effect of granting options on executive stock purchases and, in contrast to the traditional view, show that there is a natural complementarity between executive options and stock ownership, which, although intuitively straightforward, has not been identified before. The implications are explored.

Keywords: CEO compensation, managerial incentives, asymmetric information, corporate governance

JEL Classification: G30, G32, J33,