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Stock and Option Proportions in Executive Compensation

Author

Listed:
  • Phelim P. Boyle

    (School of Business and Economics, Wilfrid Laurier University, Ontario, Canada)

  • Ranjini Jha

    (School of Accounting and Finance, University of Waterloo, Ontario, Canada)

  • Shannon Kennedy

    (Department of Applied Mathematics, University of Waterloo, Ontario, Canada;
    Morgan Stanley, New York, NY, USA 10036, USA)

  • Weidong Tian

    (Department of Finance, University of North Carolina at Charlotte, North Carolina, USA 28223, USA)

Abstract

There is controversy about the relative merits of stock and options in executive compensation. Some observers contend that stock is a more efficient mechanism, while others reach the opposite conclusion. We focus on the manager's risk-taking incentives and derive an optimal compensation contract by using the concept of a comparable benchmark and imposing a volatility constraint in a principal-agent framework. We demonstrate a joint role for both stock and options in the optimal contract. We show that firms with higher volatility should use more options in compensating their executives and provide empirical evidence supporting this testable implication.

Suggested Citation

  • Phelim P. Boyle & Ranjini Jha & Shannon Kennedy & Weidong Tian, 2011. "Stock and Option Proportions in Executive Compensation," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 169-203.
    • Handle: RePEc:wsi:qjfxxx:v:01:y:2011:i:01:n:s2010139211000055
    DOI: 10.1142/S2010139211000055
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    References listed on IDEAS

    as
    1. 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.
    2. Hodder, James E. & Jackwerth, Jens Carsten, 2011. "Managerial responses to incentives: Control of firm risk, derivative pricing implications, and outside wealth management," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1507-1518, June.
    3. Brian J. Hall & Thomas A. Knox, 2002. "Managing Option Fragility," NBER Working Papers 9059, National Bureau of Economic Research, Inc.
    4. Jackwerth, Jens Carsten & Hodder, James E., 2008. "Managerial responses to incentives: Control of firm risk, derivative pricing implications, and outside wealth management," CoFE Discussion Papers 08/07, University of Konstanz, Center of Finance and Econometrics (CoFE).
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