Option Expensing and Executive Compensation

62 Pages Posted: 17 Mar 2007

See all articles by Yi Feng

Yi Feng

Ryerson University - Ted Rogers School of Management

Yisong S. Tian

York University - Schulich School of Business

Date Written: March 12, 2007


This paper examines the impact of mandatory option expensing on executive compensation. Although it merely changes the way option costs are disclosed (in footnotes or expensed in income statement), mandatory option expensing may actually alter the optimal contract between firms and their CEOs. We show theoretically that CEOs' perceived personal loss from option expensing reduces (increases) the optimal level of equity-based incentives (cash compensation). Our empirical analysis of CEO compensation using ExecuComp data supports this prediction. In addition, we find that equity incentives decline more sharply in firms that provided more excessive levels of performance pay than comparable firms do. We also find evidence that the fraction of incentives derived from stock options declines as firms comply or prepare to comply with mandatory option expensing, supporting a substitution effect between restricted stock and stock options. The documented impact of option expensing is robust to alternative explanations including the impact of the Sarbanes-Oxley Act of 2002, option backdating, different measures of equity incentives, regression specifications, and estimation methods.

Keywords: option expensing, executive compensation, incentive effects

JEL Classification: G13, G18, G38, M52, E37

Suggested Citation

Feng, Yi and Tian, Yisong Sam, Option Expensing and Executive Compensation (March 12, 2007). Available at SSRN: https://ssrn.com/abstract=970662 or http://dx.doi.org/10.2139/ssrn.970662

Yi Feng

Ryerson University - Ted Rogers School of Management ( email )

350 Victoria Street
Toronto, Ontario M5B 2K3
416-979-5000 ext. 6755 (Phone)

Yisong Sam Tian (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
416-736-2100, ext 77943 (Phone)
416-736-5687 (Fax)

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