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Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management

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  • Jackwerth, Jens Carsten
  • Hodder, James E.

Abstract

We model a firm’s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also dynamically controls allocation of his outside wealth. We explore interactions between those controls as he partially hedges his exposure to firm risk. Conditioning on his optimal behavior, control of firm risk increases the expected time to exercise for his employee stock options. It also reduces the percentage gap between his certainty equivalent and the firm’s fair value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 11643.

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Date of creation: 25 Feb 2008
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Handle: RePEc:pra:mprapa:11643

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Keywords: Risk; Wealth Management; Derivative;

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Cited by:
  1. Abudy, Menachem & Benninga, Simon, 2013. "Non-marketability and the value of employee stock options," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(12), pages 5500-5510.

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