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Executive Stock Options when Managers are Loss-Averse


  • Dittmann, Ingolf

    (Erasmus School of Economics Rotterdam)

  • Maug, Ernst

    (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504)

  • Spalt, Oliver

    (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504)


This paper analyzes optimal executive compensation contracts when managers are loss averse. We establish the general optimal contract analytically and parameterize the model using data on compensation contracts for 595 CEOs. Parameters for preferences are based on the experimental literature. Overall, the Loss Aversion-model dominates an equivalent Risk Aversion-model, especially with respect to its ability to predict options as part of the optimal contract. The Loss Aversion-model performs well in terms of predicting observed compensation contracts if the reference wage is assumed to lie not too far above previous year’s fixed wage. Our results suggest that loss aversion is a better paradigm for analyzing design features of stock options and for developing preference-based valuation models than the conventional model used in the literature.

Suggested Citation

  • Dittmann, Ingolf & Maug, Ernst & Spalt, Oliver, 2007. "Executive Stock Options when Managers are Loss-Averse," Sonderforschungsbereich 504 Publications 07-36, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  • Handle: RePEc:xrs:sfbmaa:07-36 Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.

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    References listed on IDEAS

    1. Sanjeev Bhojraj, 2002. "Who Is My Peer? A Valuation-Based Approach to the Selection of Comparable Firms," Journal of Accounting Research, Wiley Blackwell, vol. 40(2), pages 407-439, May.
    2. James Claus, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, vol. 56(5), pages 1629-1666, October.
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    4. Kaplan, Steven N & Ruback, Richard S, 1995. " The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-1093, September.
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    7. Karl Lins & Henri Servaes, 1999. "International Evidence on the Value of Corporate Diversification," Journal of Finance, American Finance Association, vol. 54(6), pages 2215-2239, December.
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    9. Volker Herrmann & Frank Richter, 2003. "Pricing With Performance-Controlled Multiples," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 55(3), pages 194-219, July.
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    11. Servaes, Henri, 1996. " The Value of Diversification during the Conglomerate Merger Wave," Journal of Finance, American Finance Association, vol. 51(4), pages 1201-1225, September.
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    Cited by:

    1. Fabian Herweg & Daniel Müller & Philipp Weinschenk, 2008. "The Optimality of Simple Contracts: Moral Hazard and Loss Aversion," Bonn Econ Discussion Papers bgse17_2008, University of Bonn, Germany.

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