IDEAS home Printed from https://ideas.repec.org/a/spr/joecth/v26y2005i4p813-837.html
   My bibliography  Save this article

Stock options and managerial optimal contracts

Author

Listed:
  • Jorge Aseff
  • Manuel Santos

Abstract

In this paper we are concerned with the performance of stock option contracts in the provision of managerial incentives. In our simple framework, we restrict the space of contracts available to the principal to those conformed by a fixed payment and a call option on the firm’s stock. As compared to the fixed payment and the option grant, we find that the strike price plays an intermediate role in the provision of insurance and incentives. We also develop some methods for the calibration of a standard principal-agent model based upon observed CEO earnings schedules and the volatility of the firm’s value in the stock market. These methods are useful to address some important issues such as the performance of stock option contracts, the degree of risk aversion compatible with current earnings profiles and the sensitivity of compensation to changes in firm’s characteristics. Copyright Springer-Verlag Berlin/Heidelberg 2005

Suggested Citation

  • Jorge Aseff & Manuel Santos, 2005. "Stock options and managerial optimal contracts," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 26(4), pages 813-837, November.
    • Handle: RePEc:spr:joecth:v:26:y:2005:i:4:p:813-837
    DOI: 10.1007/s00199-004-0563-8
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s00199-004-0563-8
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s00199-004-0563-8?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Christopher Phelan & Robert M. Townsend, 1991. "Computing Multi-Period, Information-Constrained Optima," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(5), pages 853-881.
    2. Page, Frank Jr., 1987. "The existence of optimal contracts in the principal-agent model," Journal of Mathematical Economics, Elsevier, vol. 16(2), pages 157-167, April.
    3. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    4. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 614-641, June.
    5. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    6. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    7. Gian Luca Clementi & Thomas F. Cooley, "undated". "Sensitivity of CEO Pay to Shareholder Wealth in a Dynamic Agency Model," GSIA Working Papers 2002-E13, Carnegie Mellon University, Tepper School of Business.
    8. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 653-691.
    9. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
    10. Santos, Manuel S., 1999. "Numerical solution of dynamic economic models," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 5, pages 311-386, Elsevier.
    11. Ivilina Popova & Joseph G. Haubrich, 1998. "Executive compensation: a calibration approach," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(3), pages 561-581.
    12. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    13. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563, Elsevier.
    14. Caruana, Guillermo & Celentani, Marco, 2001. "Career concerns and contingent compensation," UC3M Working papers. Economics we014811, Universidad Carlos III de Madrid. Departamento de Economía.
    15. Bengt Holmstrom & Joan Ricart i Costa, 1986. "Managerial Incentives and Capital Management," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 835-860.
    16. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    17. Bengt Holmstrom, 1999. "Managerial Incentive Problems: A Dynamic Perspective," NBER Working Papers 6875, National Bureau of Economic Research, Inc.
    18. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-276, April.
    19. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    20. R. Preston McAfee & John McMillan, 1987. "Competition for Agency Contracts," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 296-307, Summer.
    21. Edward Simpson Prescott, 1998. "Computing moral-hazard problems using the Dantzig-Wolfe decomposition algorithm," Working Paper 98-06, Federal Reserve Bank of Richmond.
    22. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-264, April.
    23. Prendergast, Canice & Stole, Lars, 1996. "Impetuous Youngsters and Jaded Old-Timers: Acquiring a Reputation for Learning," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1105-1134, December.
    24. Bengt Holmström, 1999. "Managerial Incentive Problems: A Dynamic Perspective," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 169-182.
    25. Edward Simpson Prescott, 1999. "A primer on moral-hazard models," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 47-78.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock grants as a commitment device," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2191-2216, November.
    2. Oscar Mitnik & Qiang Kang, 2008. "Not So Lucky Any More: CEO Compensation in Financially Distressed Firms," Working Papers 0906, University of Miami, Department of Economics.
    3. Arantxa Jarque, 2014. "The Complexity of CEO Compensation," Working Paper 14-16, Federal Reserve Bank of Richmond.
    4. Óscar Gutiérrez & Vicente Salas-Fumás, 2014. "Options in Agency with Binary Uncertainty," Manchester School, University of Manchester, vol. 82(2), pages 218-236, March.
    5. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    6. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    7. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
    8. Dong, Gang Nathan, 2014. "Excessive financial services CEO pay and financial crisis: Evidence from calibration estimation," Journal of Empirical Finance, Elsevier, vol. 27(C), pages 75-96.
    9. Scott Fung & Hoje Jo & Shih‐Chuan Tsai, 2009. "Agency problems in stock market‐driven acquisitions," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 8(4), pages 388-430, October.
    10. Pirjetä, Antti & Ikäheimo, Seppo & Puttonen, Vesa, 2010. "Market pricing of executive stock options and implied risk preferences," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 394-412, June.
    11. Christopher Armstrong & David Larcker & Che-Lin Su, 2007. "Stock Options and Chief Executive Compensation," Discussion Papers 1447, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    12. Christian Hofmann & Steven Huddart & Thomas Pfeiffer, 2023. "An analysis of net-outcome contracting with applications to equity-based compensation," Review of Accounting Studies, Springer, vol. 28(3), pages 1657-1689, September.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    2. Alex Edmans & Xavier Gabaix & Augustin Landier, 2007. "A Calibratable Model of Optimal CEO Incentives in Market Equilibrium," NBER Working Papers 13372, National Bureau of Economic Research, Inc.
    3. Citci, Sadettin Haluk & Inci, Eren, 2016. "The masquerade ball of the CEOs and the mask of excessive risk," Economic Modelling, Elsevier, vol. 58(C), pages 383-393.
    4. Nohel, Tom & Todd, Steven, 2005. "Compensation for managers with career concerns: the role of stock options in optimal contracts," Journal of Corporate Finance, Elsevier, vol. 11(1-2), pages 229-251, March.
    5. Jin, Li, 2002. "CEO compensation, diversification, and incentives," Journal of Financial Economics, Elsevier, vol. 66(1), pages 29-63, October.
    6. Arantxa Jarque, 2008. "CEO compensation : trends, market changes, and regulation," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 94(Sum), pages 265-300.
    7. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    8. repec:eee:labchp:v:3:y:1999:i:pb:p:2485-2563 is not listed on IDEAS
    9. Giat, Yahel & Subramanian, Ajay, 2013. "Dynamic contracting under imperfect public information and asymmetric beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2833-2861.
    10. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    11. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    12. Jenter, Dirk, 2004. "Executive Compensation, Incentives, and Risk," Working papers 4466-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    13. Chaigneau, Pierre, 2010. "The optimal timing of executive compensation," LSE Research Online Documents on Economics 119081, London School of Economics and Political Science, LSE Library.
    14. Brian J. Hall & Thomas A. Knox, 2002. "Managing Option Fragility," NBER Working Papers 9059, National Bureau of Economic Research, Inc.
    15. Hooper, Louise, 2008. "Paying for performance: Uncertainty, asymmetric information and the payment model," Research in Transportation Economics, Elsevier, vol. 22(1), pages 157-163, January.
    16. Page, T. Beau, 2018. "CEO attributes, compensation, and firm value: Evidence from a structural estimation," Journal of Financial Economics, Elsevier, vol. 128(2), pages 378-401.
    17. Pierre Chaigneau, 2010. "The Optimal Timing of Executive Compensation," FMG Discussion Papers dp660, Financial Markets Group.
    18. Amal Hili & Didier Laussel & Ngo Van Long, 2017. "Disentangling managerial incentives from a dynamic perspective: The role of stock grants," Pacific Economic Review, Wiley Blackwell, vol. 22(5), pages 743-771, December.
    19. Zhiguo He & Si Li & Bin Wei & Jianfeng Yu, 2014. "Uncertainty, Risk, and Incentives: Theory and Evidence," Management Science, INFORMS, vol. 60(1), pages 206-226, January.
    20. Rajesh K. Aggarwal & Andrew A. Samwick, 2003. "Performance Incentives within Firms: The Effect of Managerial Responsibility," Journal of Finance, American Finance Association, vol. 58(4), pages 1613-1650, August.
    21. John M. Abowd & Felipe Balmaceda & David Kaplan., "undated". "Accounting Profits, Market Profits, and the Compensation of Regular Employees," ILADES-UAH Working Papers inv119, Universidad Alberto Hurtado/School of Economics and Business.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:joecth:v:26:y:2005:i:4:p:813-837. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.