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Executive options with inflated equity prices

Author

Listed:
  • Linus Wilson
  • Yan Wendy Wu

Abstract

Purpose - – The purpose of this paper is to solve the optimal managerial compensation problem when shareholders are either naïvely optimistic or rational. Design/methodology/approach - – The paper uses applied game theory to derive the optimal CEO compensation package with over optimistic shareholders. Findings - – The results suggest that boards of directors should decrease option grants to CEOs when equity is likely to be irrationally overvalued at the date when the CEO's options vest. Research limitations/implications - – The implications of the model are consistent with the available empirical evidence. In addition, the model generates new testable predictions about managerial stock price manipulation, the number of options granted, and the magnitude of the options’ strike prices that have not yet been formally tested. Originality/value - – This is the only paper to derive closed-form solutions to optimal CEO compensation when shareholders are naïvely optimistic.

Suggested Citation

  • Linus Wilson & Yan Wendy Wu, 2014. "Executive options with inflated equity prices," International Journal of Managerial Finance, Emerald Group Publishing Limited, vol. 10(3), pages 266-292, May.
    • Handle: RePEc:eme:ijmfpp:v:10:y:2014:i:3:p:266-292
    DOI: 10.1108/IJMF-03-2011-0019
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    Citations

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    Cited by:

    1. Andergassen, Rainer, 2016. "Managerial compensation, product market competition and fraud," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 1-15.
    2. Loyola, Gino & Portilla, Yolanda, 2020. "Managerial compensation as a double-edged sword: Optimal incentives under misreporting," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 994-1017.

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