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Stock Options and Chief Executive Compensation

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  • Christopher Armstrong
  • David Larcker
  • Che-Lin Su

Abstract

Although stock options are commonly observed in chief executive officer (CEO) com- pensation contracts, there is theoretical controversy about whether stock options are part of the optimal contract. Using a sample of Fortune 500 companies, we solve an agency model calibrated to the company-specifc data and we find that stock options are almost always part of the optimal contract. This result is robust to alternative assumptions about the level of CEO risk-aversion and the disutility associated with their effort. In a supplementary analysis, we solve for the optimal contract when there are no restrictions on the contract space. We find that the optimal contract (which is characterized as a state-contingent payoff to the CEO) typically has option-like features over the most probable range of outcomes.

Suggested Citation

  • 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.
  • Handle: RePEc:nwu:cmsems:1447
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    File URL: http://www.kellogg.northwestern.edu/research/math/papers/1447.pdf
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    References listed on IDEAS

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    Cited by:

    1. Baomin Dong & Guixia Guo & Frank Yong Wang, 2013. "Dynamic Moral Hazard and Executive Stock Options," Pacific Economic Review, Wiley Blackwell, vol. 18(2), pages 259-279, May.
    2. Ng, Lilian & Sibilkov, Valeriy & Wang, Qinghai & Zaiats, Nataliya, 2011. "Does shareholder approval requirement of equity compensation plans matter?," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1510-1530.
    3. Ingolf Dittmann & Ko-Chia Yu, 2009. "How Important Are Risk-Taking Incentives in Executive Compensation?," Tinbergen Institute Discussion Papers 09-076/2, Tinbergen Institute.

    More about this item

    Keywords

    Stock Options; Incentives; Agency Model;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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