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Stock options and managerial optimal contracts

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  • Jorge Aseff

    ()

  • Manuel Santos

    ()

Abstract

In this paper we are concerned with the performance of stock option contracts in the provision of managerial incentives. In our simple framework, we restrict the space of contracts available to the principal to those conformed by a fixed payment and a call option on the firm’s stock. As compared to the fixed payment and the option grant, we find that the strike price plays an intermediate role in the provision of insurance and incentives. We also develop some methods for the calibration of a standard principal-agent model based upon observed CEO earnings schedules and the volatility of the firm’s value in the stock market. These methods are useful to address some important issues such as the performance of stock option contracts, the degree of risk aversion compatible with current earnings profiles and the sensitivity of compensation to changes in firm’s characteristics. Copyright Springer-Verlag Berlin/Heidelberg 2005

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 26 (2005)
Issue (Month): 4 (November)
Pages: 813-837

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Handle: RePEc:spr:joecth:v:26:y:2005:i:4:p:813-837

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Related research

Keywords: Stock option contract; Optimal contract; CEO earnings schedule; Stock price.;

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References

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  1. Bengt Holmstrom, 1999. "Managerial Incentive Problems: A Dynamic Perspective," NBER Working Papers 6875, National Bureau of Economic Research, Inc.
  2. Brian J. Hall & Kevin J. Murphy, 2000. "Stock Options for Undiversified Executives," NBER Working Papers 8052, National Bureau of Economic Research, Inc.
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  8. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Santos, Manuel S., 1999. "Numerical solution of dynamic economic models," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 5, pages 311-386 Elsevier.
  10. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
  11. Christopher Phelan & Robert M Townsend, 2010. "Computing Multi-Period, Information Constrained Optima," Levine's Working Paper Archive 117, David K. Levine.
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  14. Edward S. Prescott, 1998. "Computing moral-hazard problems using the Dantzig-Wolfe decomposition algorithm," Working Paper 98-06, Federal Reserve Bank of Richmond.
  15. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
  16. Prendergast, Canice & Stole, Lars, 1996. "Impetuous Youngsters and Jaded Old-Timers: Acquiring a Reputation for Learning," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1105-34, December.
  17. Guillermo Caruana & Marco Celentani, 2001. "Career Concerns And Contingent Compensation," Economics Working Papers we014811, Universidad Carlos III, Departamento de Economía.
  18. Joseph G. Haubrich & Ivilina Popova, 1994. "Executive compensation: a calibration approach," Working Paper 9416, Federal Reserve Bank of Cleveland.
  19. R. Preston McAfee & John McMillan, 1987. "Competition for Agency Contracts," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 296-307, Summer.
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Citations

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Cited by:
  1. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock grants as a commitment device," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2191-2216, November.
  2. Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A time series analysis of financial fragility in the UK banking system," LSE Research Online Documents on Economics 24778, London School of Economics and Political Science, LSE Library.
  3. Scott Fung & Hoje Jo & Shih-Chuan Tsai, 2009. "Agency problems in stock market-driven acquisitions," Review of Accounting and Finance, Emerald Group Publishing, vol. 8(4), pages 388 - 430, November.
  4. Calcagno, R. & Renneboog, L.D.R., 2004. "Capital Structure and Managerial Compensation: The Effects of Remuneration Seniority," Discussion Paper 2004-015, Tilburg University, Tilburg Law and Economic Center.
  5. Pirjetä, Antti & Ikäheimo, Seppo & Puttonen, Vesa, 2010. "Market pricing of executive stock options and implied risk preferences," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 394-412, June.
  6. Oscar Mitnik & Qiang Kang, 2008. "Not So Lucky Any More: CEO Compensation in Financially Distressed Firms," Working Papers 0906, University of Miami, Department of Economics.
  7. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  8. Christopher Armstrong & David Larcker & Che-Lin Su, 2007. "Stock Options and Chief Executive Compensation," Discussion Papers 1447, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

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