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Stock options and managerial incentives to invest

Listed author(s):
  • Nohel, Tom

    (Loyola University Chicago)

  • Steven Todd
Registered author(s):

    We examine the effect of stock options on managerial incentives to invest. Our chief innovation is a model wherein firm value and executive decisions are endogenous. Numerical solutions to our model show that managerial incentives to invest are multi-dimensional and highly sensitive to option strike prices, the manager's wealth, degree of diversification, risk aversion, and career concerns. We find that over-investment problems are far more likely and far more severe that many researchers suggest. Finally, firm value is not a strictly increasing function of a manager's incentive compensation or conventional pay-for-performance metrics. Stronger managerial incentives to invest can benefit or harm a firm. Our results should send a cautionary signal to researchers who study managerial behavior. It is not sufficient to rely on one-dimensional risk-neutral valuation metrics, such as pay-for-performance, to describe the degree of incentive alignment between managers and shareholders.

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    Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2002 with number 149.

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    Date of creation: 29 Aug 2002
    Handle: RePEc:ecj:ac2002:149
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