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Optimal Incentive Contracts for Loss-Averse Managers: Stock Options versus Restricted Stock Grants

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  • Anna Dodonova
  • Yuri Khoroshilov

Abstract

This paper provides an explanation for the widespread use of stock option grants in executive compensation. It shows that the optimal incentive contract for loss-averse managers must contain a substantial portion of stock options even when it should consist exclusively of stock grants for "classical" risk-averse managers. The paper also provides an explanation for the drastic increase in the risk-adjusted level of CEO compensations over the past two decades and argues that more option-based compensation should be used in firms with higher cash flow volatility and in industries with a higher degree of heterogeneity among firms. Copyright 2006, The Eastern Finance Association.

Suggested Citation

  • Anna Dodonova & Yuri Khoroshilov, 2006. "Optimal Incentive Contracts for Loss-Averse Managers: Stock Options versus Restricted Stock Grants," The Financial Review, Eastern Finance Association, vol. 41(4), pages 451-482, November.
  • Handle: RePEc:bla:finrev:v:41:y:2006:i:4:p:451-482
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6288.2006.00153.x
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    Cited by:

    1. Yuri Khoroshilov, 2012. "Incentive Contracts for Overoptimistic Managers," Economics Bulletin, AccessEcon, vol. 32(2), pages 1687-1694.
    2. Dodonova, Anna & Khoroshilov, Yuri, 2014. "Compensation and performance: An experimental study," Economics Letters, Elsevier, vol. 124(2), pages 304-307.

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