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.
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| Length: | |
| Date of creation: | Feb 2000 |
| Date of revision: | |
| Publication status: | published as American Economic Review, Vol. 90, no. 2 (May 2000): 209-214 |
| Handle: | RePEc:nbr:nberwo:7548 |
| Note: | CF LS PE |
| Contact details of provider: | Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A. Phone: 617-868-3900 Web page: http://www.nber.org Email: More information through EDIRC
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References listed on IDEAS
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- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Brian J. Hall & Jeffrey B. Liebman, 1998.
"Are CEOs Really Paid Like Bureaucrats?,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 113(3), pages 653-691.
- Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Really Paid Like Bureaucrats?," NBER Working Papers 6213, National Bureau of Economic Research, Inc.
- 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.
- Brian J. Hall & Kevin J. Murphy, 2000.
"Stock Options for Undiversified Executives,"
NBER Working Papers
8052, National Bureau of Economic Research, Inc.
- 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.
- Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
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