Information asymmetry, contract design and process of negotiation: The stock options awarding case
AbstractStock option plans are used to increase managerial incentives, and business practices usually set the exercise price equal to the stock market price. The purpose of this paper is to underline the importance of a process of negotiation leading to a possible equilibrium contract satisfying both managers and shareholders. The two key variables of the model are the percentage of equity capital offered by the shareholders to the managers and the exercise price of the options that may be at a discount. We explicitly introduce risk aversion and information asymmetries in the form of (i) an economic uncertainty in the gain of cash flow, (ii) possibly biased information between the two parties and (iii) a noise in the valuation price of the stock in the market. The existence of a process of negotiation between shareholders and managers leading to a possible disclosure of private information is highlighted. As a conclusion, we show that “efficient” stock option plans should be granted in a context of trade-off between the percentage of capital awarded to managers and the discount in stock price.
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Bibliographic InfoPaper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/12534.
Date of creation: Apr 2008
Date of revision:
Publication status: Published in Journal of corporate finance, 2008, Vol. 14, no. 2. pp. 73-91.Length: 18 pages
Optimal incentive contract; Stock-options; Asymmetry of information; Negotiation; Managerial power;
Find related papers by JEL classification:
- K2 - Law and Economics - - Regulation and Business Law
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- G3 - Financial Economics - - Corporate Finance and Governance
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- Avdjiev, Stefan & Zeng, Zheng, 2009. "Impact of heterogeneous managerial productivity on executive hedge markets in an asymmetric information environment," Finance Research Letters, Elsevier, vol. 6(4), pages 187-201, December.
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