The Efficiency of Equity-Linked Compensation: Understanding the Full Cost of Awarding Executive Stock Options

Meulbroek, Lisa K.

doi:10.2139/ssrn.215530

Cited by 138 publications

(153 citation statements)

References 7 publications

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“…Although based on a fundamentally different logic, this is consistent with previous research by Lambert, Larcker and Verrechia (1991), Meulbroek (2001), Hall and Murphy (2002) and Buck, Bruce, Main and Udueni (2003), on which we comment further in the theory and discussion sections. The paper proceeds as follows.…”

Section: Introductionsupporting

confidence: 90%

The economic psychology of incentives: An international study of top managers

Pepper

Gore

2014

Journal of World Business

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The world-wide inflation in executive compensation in recent years has been accompanied by an increase in the prevalence of long-term incentives. This article demonstrates how the subjectively perceived value of long-term incentives is affected by risk aversion, uncertainty aversion, and time preferences. Based on a unique empirical study which involved collecting primary data on executive preferences from around the world, and using a theoretical framework which draws on behavioral agency theory, we conclude that, while long-term incentives are perceived by executives to be effective, they are not in fact an efficient form of reward. This outcome is not significantly affected by cross-cultural differences. We conjecture that boards of directors, acting on behalf of shareholders, increase the size of longterm incentive awards in order to compensate executives for the perceived loss of value when compared with less risky, more certain and more immediate forms of reward.

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Section: Introductionsupporting

confidence: 90%

The economic psychology of incentives: An international study of top managers

Pepper

Gore

2014

Journal of World Business

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“…Using risk aversion coeffcients between 2 and 8 yields qualitatively similar results. 23 The result is in fact slightly different from Hall and Murphy (2000a,b) and closer to Meulbroek (2001), since both our model and Meulbroek explicitly compare the executive stock or option grant to an investment into the market asset. Unlike Meulbroek, the manager optimally invests her private wealth and any cash portion of compensation.…”

Section: Section 21: Restricted Stock Grants Versus Restricted Optiocontrasting

confidence: 74%

“…The ratio of the executive's valuation relative to the market value of the stock grant is reported in the second row of Panel A. This is the result noted by Lambert, Larcker and Verrecchia (1991), Hall and Murphy (2000 a,b) and Meulbroek (2001) for option grants, and due to the fact that any risk-averse agent prefers the higher Sharpe-ratio offered by the risky market asset. 23 21 More appropriately, cash renumeration should be discounted at the borrowing rate of the company, risk-adjusted for the level of seniority.…”

Section: Section 21: Restricted Stock Grants Versus Restricted Optiosupporting

confidence: 64%

“…31 See Holmstrom (1982) and Gibbons and Murphy (1990). retained. 32 At the bottom of Table III, the total cost of compensation is compared to restricted stock and non-indexed options. Incentive creation with indexed options is more expensive than with stock grants, but less expensive than with standard non-indexed options.…”

Section: Section 23: the Effect Of Private Trading On Valuation And mentioning

confidence: 99%

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Executive Compensation, Incentives, and Risk

Jenter

2004

SSRN Journal

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Executive Compensation, Incentives, and Risk 1 This paper analyzes the link between equity-based compensation and created incentives by (1) deriving a measure of incentives suitable for both linear and non-linear compensation contracts, (2) analyzing the effect of risk on incentives, and (3) clarifying the role of the agent's private trading decisions in incentive creation. With option-based compensation contracts, the average pay-forperformance sensitivity is not an adequate measure of ex-ante incentives. Pay-for-performance covaries negatively with marginal utility and hence overstates the created incentives. Second, more noise in the performance measure implies that the manager is less certain about the effect of effort on performance, which in turn makes her less willing to exert effort. Finally, the private trading decisions by the manager have first-order effects on incentives. By reducing her holdings of the market asset, the manager achieves an effect similar to "indexing" the stock or option grant, making explicit indexation of the contract redundant.

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“…It is estimated that, under reasonable conditions, individuals evaluate e.g. a standard option program of less than 60 percent of the cost to the providing firm (Hall & Murphy 2002;Meulbroeck 2000).…”

Section: Potential Counterargumentsmentioning

confidence: 99%

Shareholders Should Welcome Employees as Directors

Osterloh

Frey

2005

SSRN Journal

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The most influential theory of corporate governance, principal agency theory, does not take into consideration that the key task of modern corporations is to generate and transfer firm-specific knowledge. It proposes that, in order to overcome the widespread corporate scandals, the interests of top management and directors should be increasingly aligned to shareholder interests by making the board more responsible to shareholders, and strengthening the monitoring of top management by independent outside directors. Corporate governance reform needs to go in another direction altogether. Firm-specific knowledge investments are, like financial investments, not ex ante contractible, leaving investors open to exploitation by shareholders. Employees therefore refuse to make firm-specific investments. To gain a sustainable competitive advantage, there must be an incentive to undertake such firm-specific investments. Three proposals are advanced to deal with this conflict: (1) The board should rely more on insiders. (2) The insiders should be elected by those employees of the firm making firm-specific knowledge investments.(3) The board should be chaired by a neutral person. These proposals have major advantages: they provide incentives for knowledge investors; they countervail the dominance of executives; they encourage intrinsic work motivation and loyalty to the firm by strengthening distributive and procedural justice, and they ensure diversity on the board while lowering transaction costs. These proposals for reforming the board may help to overcome the crisis corporate governance is in. At the same time, they connect agency theory with the knowledge-based theory of the firm.(243 words)

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The Efficiency of Equity-Linked Compensation: Understanding the Full Cost of Awarding Executive Stock Options

Cited by 138 publications

References 7 publications

The economic psychology of incentives: An international study of top managers

The economic psychology of incentives: An international study of top managers

Executive Compensation, Incentives, and Risk

Shareholders Should Welcome Employees as Directors

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