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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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File URL: http://hdl.handle.net/10.1007/s00199-004-0563-8
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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. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Gian Luca Clementi & Thomas F. Cooley, . "Sensitivity of CEO Pay to Shareholder Wealth in a Dynamic Agency Model," GSIA Working Papers 2002-E13, Carnegie Mellon University, Tepper School of Business.
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  7. 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.
  8. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
  9. Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Really Paid Like Bureaucrats?," NBER Working Papers 6213, National Bureau of Economic Research, Inc.
  10. 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.
  11. Joseph G. Haubrich, 1991. "Risk aversion, performance pay, and the principal-agent problem," Working Paper 9118, Federal Reserve Bank of Cleveland.
  12. Christopher Phelan & Robert M Townsend, 2010. "Computing Multi-Period, Information Constrained Optima," Levine's Working Paper Archive 117, David K. Levine.
  13. Ivilina Popova & Joseph G. Haubrich, 1998. "Executive compensation: a calibration approach," Economic Theory, Springer, vol. 12(3), pages 561-581.
  14. Page, Frank Jr., 1987. "The existence of optimal contracts in the principal-agent model," Journal of Mathematical Economics, Elsevier, vol. 16(2), pages 157-167, April.
  15. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  16. R. Preston McAfee & John McMillan, 1987. "Competition for Agency Contracts," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 296-307, Summer.
  17. Guillermo Caruana & Marco Celentani, 2001. "Career Concerns And Contingent Compensation," Economics Working Papers we014811, Universidad Carlos III, Departamento de Economía.
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  19. 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.
  20. 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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Citations

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Cited by:
  1. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock Grants As a Commitment Device," Staff General Research Papers 12300, Iowa State University, Department of Economics.
  2. 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.
  3. 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.
  4. 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.
  5. Kang, Qiang & Mitnik, Oscar A., 2008. "Not So Lucky Any More: CEO Compensation in Financially Distressed Firms," IZA Discussion Papers 3857, Institute for the Study of Labor (IZA).
  6. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  7. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
  8. 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.

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