Optimal Exercise Prices for Executive Stock Options
Although exercise prices for executive stock options can be set either below or above the grant-date market price, in practice virtually all options are granted at the money. We offer an economic rationale for this apparent puzzle, by showing that pay-to-performance incentives for risk-averse undiversified executives are typically maximized by setting exercise prices at (or near) the grant-date market price. We provide an operationally useful alternative to Black-Scholes (1973) for the purpose of both valuing executive stock options and measuring the incentives created by options. Our framework has implications not only for exercise-price policies, but also for indexed options, option repricings, exchanges of cash for stock-based compensation, and the design of bonus plans.
|Date of creation:||Feb 2000|
|Date of revision:|
|Publication status:||published as American Economic Review, Vol. 90, no. 2 (May 2000): 209-214|
|Note:||CF LS PE|
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- Brian J. Hall & Jeffrey B. Liebman, 1998.
"Are CEOs Really Paid Like Bureaucrats?,"
The Quarterly Journal of Economics,
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- 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.
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