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Optimal executive compensation: Stock options or restricted stocks

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  • Wu, Yan Wendy
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    Abstract

    This paper develops an agency model to analyze the optimality of executive stock option compensation in the presence of information manipulation. The analyses show that although information manipulation is positively related to the size of option compensation, the relative size of manipulation-to-effort does not depend on the size of option compensation. Furthermore, an optimal executive compensation package includes stock options instead of restricted stocks under most circumstances. Testable predictions on the relationship between optimal option exercise price and exogenous model parameters are derived.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1059056010001322
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    Bibliographic Info

    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 20 (2011)
    Issue (Month): 4 (October)
    Pages: 633-644

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    Handle: RePEc:eee:reveco:v:20:y:2011:i:4:p:633-644

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    Web page: http://www.elsevier.com/locate/inca/620165

    Related research

    Keywords: Executive compensation Information manipulation Stock option Corporate governance;

    References

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    1. Efendi, Jap & Srivastava, Anup & Swanson, Edward P., 2007. "Why do corporate managers misstate financial statements? The role of option compensation and other factors," Journal of Financial Economics, Elsevier, vol. 85(3), pages 667-708, September.
    2. Patrick Bolton & Jose Scheinkman & Wei Xiong, 2003. "Executive Compensation and Short-termist Behavior in Speculative Markets," NBER Working Papers 9722, National Bureau of Economic Research, Inc.
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    4. Xie, Feixue, 2009. "Managerial flexibility, uncertainty, and corporate investment: The real options effect," International Review of Economics & Finance, Elsevier, vol. 18(4), pages 643-655, October.
    5. Ohad Kadan, 2008. "Stocks or Options? Moral Hazard, Firm Viability, and the Design of Compensation Contracts," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 451-482, January.
    6. Maug, Ernst & Dittmann, Ingolf, 2007. "Lower Salaries and No Options: The Optimal Structure of Executive Pay," Sonderforschungsbereich 504 Publications 07-41, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
    7. Erik Lie, 2005. "On the Timing of CEO Stock Option Awards," Management Science, INFORMS, vol. 51(5), pages 802-812, May.
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    13. Palmon, Oded & Bar-Yosef, Sasson & Chen, Ren-Raw & Venezia, Itzhak, 2008. "Optimal strike prices of stock options for effort-averse executives," Journal of Banking & Finance, Elsevier, vol. 32(2), pages 229-239, February.
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    16. Brian J. Hall & Kevin J. Murphy, 2000. "Optimal Exercise Prices for Executive Stock Options," NBER Working Papers 7548, National Bureau of Economic Research, Inc.
    17. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    18. Louis, Henock, 2004. "Earnings management and the market performance of acquiring firms," Journal of Financial Economics, Elsevier, vol. 74(1), pages 121-148, October.
    19. David Yermack, 1996. "Good Timing: CEO Stock Option Awards and Company News Announcements," New York University, Leonard N. Stern School Finance Department Working Paper Seires 96-41, New York University, Leonard N. Stern School of Business-.
    20. Johnson, Shane A. & Tian, Yisong S., 2000. "The value and incentive effects of nontraditional executive stock option plans," Journal of Financial Economics, Elsevier, vol. 57(1), pages 3-34, July.
    21. Lin Peng & Ailsa Röell, 2008. "Executive pay and shareholder litigation," Review of Finance, European Finance Association, vol. 12(1), pages 141-184.
    22. Darrough, Masako N & Stoughton, Neal M, 1986. " Moral Hazard and Adverse Selection: The Question of Financial Structure," Journal of Finance, American Finance Association, vol. 41(2), pages 501-13, June.
    23. Ingolf Dittmann & Ernst Maug, 2007. "Lower Salaries and No Options? On the Optimal Structure of Executive Pay," Journal of Finance, American Finance Association, vol. 62(1), pages 303-343, 02.
    24. Cadenillas, Abel & Cvitanic, Jaksa & Zapatero, Fernando, 2004. "Leverage decision and manager compensation with choice of effort and volatility," Journal of Financial Economics, Elsevier, vol. 73(1), pages 71-92, July.
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    Cited by:
    1. Chen, Ching-Lung & Lu, Ming-Che & Yen, Gili, 2012. "Dilution/incentive effects associating with employee bonuses in Taiwan: Empirical findings under two regimes," International Review of Economics & Finance, Elsevier, vol. 22(1), pages 267-283.

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