Estimating the Cost of Executive Stock Options: Evidence from Switzerland
AbstractIt is often argued that Black-Scholes (1973) values overstate the subjective value of stock options granted to risk-averse and under-diversified executives. We construct a “representative” Swiss executive and extend the certainty- equivalence approach presented by Hall and Murphy (2002) to assess the value-cost wedge of executive stock options. Even with low coefficients of relative risk aversion, the discount can be above 50% compared to the Black-Scholes values. Regression analysis reveals that the equilibrium level of executive compensation is explained by economic determinant variables such as firm size and growth opportunities, whereas the managers’ pay-forperformance sensitivity remains largely unexplained. Firms with larger boards of directors pay higher wages, indicating potentially unresolved agency conflicts. We reject the hypothesis that cross-sectional differences in the amount of executive pay vanish when risk-adjusted values are used as the dependent variable.
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Bibliographic InfoPaper provided by Faculty of Business and Economics - University of Basel in its series Working papers with number 2007/17.
Date of creation: 2007
Date of revision:
Managerial compensation; incentives; executive stock options; option valuation; risk aversion;
Find related papers by JEL classification:
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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