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


  • Anna Dodonova
  • Yuri Khoroshilov


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.

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
    DOI: 10.1111/j.1540-6288.2006.00153.x

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    Cited by:

    1. Liu, Sun, 2017. "The impact of equity incentive plans on analysts’ earnings forecasts and stock recommendations for Chinese listed firms: An empirical study," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 29(C), pages 1-13.
    2. Yuri Khoroshilov, 2012. "Incentive Contracts for Overoptimistic Managers," Economics Bulletin, AccessEcon, vol. 32(2), pages 1687-1694.
    3. Dodonova, Anna & Khoroshilov, Yuri, 2014. "Compensation and performance: An experimental study," Economics Letters, Elsevier, vol. 124(2), pages 304-307.

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