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Stock Options and Chief Executive Compensation

  • Christopher Armstrong
  • David Larcker
  • Che-Lin Su

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.

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1447.

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Date of creation: May 2007
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Handle: RePEc:nwu:cmsems:1447
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