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Stock Options and Managerial Optimal Contracts

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Author Info
Manuel Santos () (W. P. Carey School of Business Department of Economics)
Jorge Aseff () (No affiliation)

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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 package of call options on the firm's stock. We then offer a characterization of optimal stock option compensation schemes. 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 efficient algorithms for the computation of optimal contracts in which the observable outcome is drawn from a continuous distribution. These algorithms are useful to address some important issues such as the calibration of a principal-agent model, the degree of risk aversion compatible with current compensation schemes, and the performance of stock option contracts.

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Paper provided by Department of Economics, W. P. Carey School of Business, Arizona State University in its series Working Papers with number 2133304.

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Handle: RePEc:asu:wpaper:2133304

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  2. Edward S. Prescott, 1998. "Computing moral-hazard problems using the Dantzig-Wolfe decomposition algorithm," Working Paper 98-06, Federal Reserve Bank of Richmond. [Downloadable!]
  3. Guillermo Caruana & Marco Celentani, 2001. "Career Concerns And Contingent Compensation," Economics Working Papers we014811, Universidad Carlos III, Departamento de Economía. [Downloadable!]
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  5. 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. [Downloadable!] (restricted)
  6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
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  8. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April. [Downloadable!] (restricted)
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  9. 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. [Downloadable!] (restricted)
  10. 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. [Downloadable!] (restricted)
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  12. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June. [Downloadable!] (restricted)
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  13. Holmstrom, Bengt, 1999. "Managerial Incentive Problems: A Dynamic Perspective," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 169-82, January. [Downloadable!] (restricted)
  14. Bengt Holmstrom, 1999. "Managerial Incentive Problems: A Dynamic Perspective," NBER Working Papers 6875, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Robert Gibbons & Kevin J. Murphy, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," NBER Working Papers 3792, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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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. [Downloadable!] (restricted)
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  1. Calcagno, R. & Renneboog, L.D.R., 2004. "Capital structure and managerial compensation : the effects of remuneration seniority," Discussion Paper 120, Tilburg University, Center for Economic Research. [Downloadable!]
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  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. [Downloadable!]
  3. Gian Luca Clementi & Thomas Cooley & Chen Wang, 2004. "Stock Grants as a Committment Device," Working Papers 04-24, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
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  4. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie). [Downloadable!]
  5. 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. [Downloadable!] (restricted)
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  6. 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). [Downloadable!]
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