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Leverage, Volatility and Executive Stock Options

  • Choe, Chongwoo

Leverage, Volatility and Executive Stock Options Abstract This paper studies how an optimal wage contract can be implemented using stock options, and derives the properties of the optimal contract with stock options. Specifically, we show how the exercise price and the size of the option grant should change in respose to changes in exogenous parameter. First, for a fixed exercise price of executive stock options, the size of the option grant decreases in the riskiness of a desired investment policy, decreases in the volatility of return from the risky project, and increases in leverage. Second, for a fixed size of the option grant, the optimal exercise price of managerial stock options increases in the riskiness of a desired investment policy, increases in the volatility of return from the risky project, and decreases in leverage. Several empirical predictions are drawn from these conclusions regarding the pay-performance sensitivity of management compensation.

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File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/13851/1/DP420.pdf
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Paper provided by Institute of Economic Research, Hitotsubashi University in its series Discussion Paper Series with number a420.

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Length: 22, [2] p.
Date of creation: Dec 2001
Date of revision:
Handle: RePEc:hit:hituec:a420
Note: Bibliography: p. 21-22
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  1. Bebchuk, Lucian Arye & Fried, Jesse M. & Walker, David I., 2001. "Executive Compensation in America: Optimal Contracting or Extraction of Rents?," Berkeley Olin Program in Law & Economics, Working Paper Series qt1x24r7st, Berkeley Olin Program in Law & Economics.
  2. Brenner, Menachem & Sundaram, Rangarajan K. & Yermack, David, 2000. "Altering the terms of executive stock options," Journal of Financial Economics, Elsevier, vol. 57(1), pages 103-128, July.
  3. Brian J. Hall & Jeffrey B. Liebman, 2000. "The Taxation of Executive Compensation," NBER Working Papers 7596, National Bureau of Economic Research, Inc.
  4. Brian J. Hall & Jeffrey B. Liebman, 1998. "Are CEOs Really Paid Like Bureaucrats?," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 653-691, August.
  5. Jennifer Carpenter, 1999. "Does Option Compensation Increase Managerial Risk Appetite?," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-076, New York University, Leonard N. Stern School of Business-.
  6. Acharya, Viral V. & John, Kose & Sundaram, Rangarajan K., 2000. "On the optimality of resetting executive stock options," Journal of Financial Economics, Elsevier, vol. 57(1), pages 65-101, July.
  7. 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 225-64, April.
  8. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
  9. Gilson, Stuart C & Vetsuypens, Michael R, 1993. " CEO Compensation in Financially Distressed Firms: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 48(2), pages 425-58, June.
  10. Lucian Arye Bebchuk & Jesse M. Fried & David I. Walker, 2001. "Executive Compensation in America: Optimal Contracting or Extraction of Rents?," NBER Working Papers 8661, National Bureau of Economic Research, Inc.
  11. Berkovitch, Elazar & Israel, Ronen, 1996. "The Design of Internal Control and Capital Structure," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 209-40.
  12. Brennan, M J, 1979. "The Pricing of Contingent Claims in Discrete Time Models," Journal of Finance, American Finance Association, vol. 34(1), pages 53-68, March.
  13. Zender, Jaime F, 1991. " Optimal Financial Instruments," Journal of Finance, American Finance Association, vol. 46(5), pages 1645-63, December.
  14. Kevin J. Murphy & Brian J. Hall, 2000. "Optimal Exercise Prices for Executive Stock Options," American Economic Review, American Economic Association, vol. 90(2), pages 209-214, May.
  15. Haugen, Robert A & Senbet, Lemma W, 1981. "Resolving the Agency Problems of External Capital through Options," Journal of Finance, American Finance Association, vol. 36(3), pages 629-47, June.
  16. Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
  17. 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.
  18. Yermack, David, 1995. "Do corporations award CEO stock options effectively?," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 237-269.
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