Stock Options and Chief Executive Officer Compensation

Abstract

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Is CEO Pay Really Inefficient? A Survey of New Optimal Contracting Theories

“…Dittmann and Yu (2008) show that observed compensation structures can be rationalized even with exponential utility, if the CEO chooses firm risk in addition to effort, since options provide stronger risk‐taking incentives. Armstrong et al (2007) find that options are part of the optimal contract when jointly endogenising the target effort level in addition to the contract structure, with a lower bound on cash salary, and under the assumption that the market does not anticipate the compensation contract. Kadan and Swinkels (2008) demonstrate theoretically that options are a stronger motivator than stock if bankruptcy risk is small and show empirically that lower bankruptcy risk is indeed associated with more use of options.…”

Dynamic Moral Hazard and Executive Stock Options

“…The FOA problem is even more severe when stock options (which are convex in the firm value) are included in the compensation package, because, in this case, the objective function of the agent becomes a non-concave function of his or her action. For detailed discussion, interested readers may refer to Hemmer et al (2000), Lambert and Larcker (2004) and Armstrong et al (2007). In the basic model, we consider a two-period moral hazard problem: the manager works for the shareholder for two periods before the project value is realized. Similar to Holmstrom and Milgrom (1987), we assume the manager gets paid according to the final project value, and the manager can observe the project value in each period.…”

“…In contrast to the previous literature that exogenously assumes that the compensation contract consists of a base wage, restricted stocks and stock options (e.g. Lambert and Larcker, ; Dittmann and Maug, ; Armstrong et al ., ), our model justifies the optimality of the widespread use of executive stock options endogenously. This result is robust even if we extend our model into infinite periods.…”

Does shareholder approval requirement of equity compensation plans matter?

“…8 Morgan and Poulsen (2001) report positive market reactions to management-sponsored equity compensation proposals, as well as more votes in favor of such plans in firms with higher agency problems. Among more recent studies, Armstrong et al (2007) show that stock options are almost always a part of the optimal compensation contract. Edmans et al (2009) and Gabaix and Landier (2008) claim that recent increases in pay are consistent with the model of competitive matching for managerial talent, and show that equity incentives are able to moderate the agency problems at large.…”