TY - JOUR
T1 - Optimal strike prices of stock options for effort-averse executives
AU - Palmon, Oded
AU - Bar-Yosef, Sasson
AU - Chen, Ren Raw
AU - Venezia, Itzhak
PY - 2008/2
Y1 - 2008/2
N2 - This paper evaluates the common practice of setting the strike prices of executive option plans at-the-money. Hall and Murphy [Hall, Brian, Murphy, Kevin J., 2000. Optimal exercise prices for executive stock options. American Economic Review 90 (2), 209-214] claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance. However, they do not incorporate effort and the possibility that managers are effort-averse into their model. We revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages, options, and stock grants. We simulate the manager's effort choice and compensation as well as the value of shareholders' equity under alternative compensation schemes, and identify schemes that are optimal. Our simulations indicate that, when abstracting from tax considerations, it is optimal to award managers with options that will most likely be highly valuable (i.e., substantially in-the-money) on their expiration date. Prior to 2006, the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations. Recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006.
AB - This paper evaluates the common practice of setting the strike prices of executive option plans at-the-money. Hall and Murphy [Hall, Brian, Murphy, Kevin J., 2000. Optimal exercise prices for executive stock options. American Economic Review 90 (2), 209-214] claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance. However, they do not incorporate effort and the possibility that managers are effort-averse into their model. We revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages, options, and stock grants. We simulate the manager's effort choice and compensation as well as the value of shareholders' equity under alternative compensation schemes, and identify schemes that are optimal. Our simulations indicate that, when abstracting from tax considerations, it is optimal to award managers with options that will most likely be highly valuable (i.e., substantially in-the-money) on their expiration date. Prior to 2006, the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations. Recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006.
KW - Effort aversion
KW - Executive compensation
KW - Managerial incentives
KW - Stock options
KW - Strike prices
UR - http://www.scopus.com/inward/record.url?scp=38749150037&partnerID=8YFLogxK
U2 - 10.1016/j.jbankfin.2007.03.015
DO - 10.1016/j.jbankfin.2007.03.015
M3 - 文章
AN - SCOPUS:38749150037
SN - 0378-4266
VL - 32
SP - 229
EP - 239
JO - Journal of Banking and Finance
JF - Journal of Banking and Finance
IS - 2
ER -