IDEAS home Printed from https://ideas.repec.org/a/kap/annfin/v11y2015i3p383-410.html
   My bibliography  Save this article

Evidence on exercise pricing in CEO option grants in two countries

Author

Listed:
  • Jean Canil
  • Bruce Rosser

Abstract

This paper examines the relationship between exercise prices, grant size and CEO risk aversion employing a data set of Australian option grants characterized by exercise prices that vary relative to the stock price. We argue that Australian exercise price and grant size decisions provide an appropriate framework for evaluating the consequences of the U.S. practice of granting at-the-money options. Using a 3SLS estimation, we find that exercise prices are positive in grant size when internalizing CEO risk aversion but less so for the U.S. relative to Australia. We find also that CEO risk aversion is negatively related to both exercise prices and grant size in Australia but negatively related only to exercise prices in the U.S. A positive relation found between CEO risk aversion and grant size in the U.S. implies that risk aversion is addressed with larger grant sizes to compensate for fixed exercise prices. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Jean Canil & Bruce Rosser, 2015. "Evidence on exercise pricing in CEO option grants in two countries," Annals of Finance, Springer, vol. 11(3), pages 383-410, November.
    • Handle: RePEc:kap:annfin:v:11:y:2015:i:3:p:383-410
    DOI: 10.1007/s10436-015-0262-4
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s10436-015-0262-4
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s10436-015-0262-4?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Andrew Trumble & Sean Pinder, 2012. "Evidence of managerial opportunism in Australia," Accounting Research Journal, Emerald Group Publishing Limited, vol. 25(1), pages 25-40, July.
    2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    3. Ingolf Dittmann & Ernst Maug, 2007. "Lower Salaries and No Options? On the Optimal Structure of Executive Pay," Journal of Finance, American Finance Association, vol. 62(1), pages 303-343, February.
    4. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    5. Kevin J. Murphy & Brian J. Hall, 2000. "Optimal Exercise Prices for Executive Stock Options," American Economic Review, American Economic Association, vol. 90(2), pages 209-214, May.
    6. Jeff Coulton & Stephen Taylor, 2002. "Option Awards for Australian CEOs: The Who, What and Why," Australian Accounting Review, CPA Australia, vol. 12(26), pages 25-35, March.
    7. Giovanni Cerulli, 2012. "Ivtreatreg: a new STATA routine for estimating binary treatment models with heterogeneous response to treatment under observable and unobservable selection," CERIS Working Paper 201203, CNR-IRCrES Research Institute on Sustainable Economic Growth - Torino (TO) ITALY - former Institute for Economic Research on Firms and Growth - Moncalieri (TO) ITALY.
    8. Murray Carlson & Ali Lazrak, 2010. "Leverage Choice and Credit Spreads when Managers Risk Shift," Journal of Finance, American Finance Association, vol. 65(6), pages 2323-2362, December.
    9. Tang, Chun-Hua, 2012. "Revisiting the incentive effects of executive stock options," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 564-574.
    10. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-264, April.
    11. Lewellen, Katharina, 2006. "Financing decisions when managers are risk averse," Journal of Financial Economics, Elsevier, vol. 82(3), pages 551-589, December.
    12. Scott Schaefer, 1998. "The Dependence Of Pay--Performance Sensitivity On The Size Of The Firm," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 436-443, August.
    13. Alex Edmans & Xavier Gabaix, 2011. "The Effect of Risk on the CEO Market," The Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2822-2863.
    14. Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, vol. 63(2), pages 134-139, May.
    15. Wolfgang Drobetz & Pascal Pensa & Markus M. Schmid, 2007. "Estimating the Cost of Executive Stock Options: evidence from Switzerland," Corporate Governance: An International Review, Wiley Blackwell, vol. 15(5), pages 798-815, September.
    16. Bebchuk, Lucian Arye & Fried, Jesse & Walker, David I, 2002. "Managerial Power and Rent Extraction in the Design of Executive Compensation," CEPR Discussion Papers 3558, C.E.P.R. Discussion Papers.
    17. Choe, Chongwoo, 2003. "Leverage, volatility and executive stock options," Journal of Corporate Finance, Elsevier, vol. 9(5), pages 591-609, November.
    18. Lucian Bebchuk & Jesse Fried, 2002. "Power, rent extraction, and executive compensation," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 3(03), pages 23-28, October.
    19. Ali Lazrak & Murray Carlson, 2010. "Leverage Choice and Credit Spreads when Managers Risk Shift," Post-Print hal-00585953, HAL.
    20. Himmelberg, Charles P. & Hubbard, R. Glenn & Palia, Darius, 1999. "Understanding the determinants of managerial ownership and the link between ownership and performance," Journal of Financial Economics, Elsevier, vol. 53(3), pages 353-384, September.
    21. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    22. Martin J. Conyon & John E. Core & Wayne R. Guay, 2011. "Are U.S. CEOs Paid More Than U.K. CEOs? Inferences from Risk-adjusted Pay," The Review of Financial Studies, Society for Financial Studies, vol. 24(2), pages 402-438.
    23. Eli Ofek & David Yermack, 2000. "Taking Stock: Equity‐Based Compensation and the Evolution of Managerial Ownership," Journal of Finance, American Finance Association, vol. 55(3), pages 1367-1384, June.
    24. Berger, Philip G & Ofek, Eli & Yermack, David L, 1997. "Managerial Entrenchment and Capital Structure Decisions," Journal of Finance, American Finance Association, vol. 52(4), pages 1411-1438, September.
    25. Demsetz, Harold & Lehn, Kenneth, 1985. "The Structure of Corporate Ownership: Causes and Consequences," Journal of Political Economy, University of Chicago Press, vol. 93(6), pages 1155-1177, December.
    26. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2008. "Boards: Does one size fit all," Journal of Financial Economics, Elsevier, vol. 87(2), pages 329-356, February.
    27. George P. Baker & Brian J. Hall, 2004. "CEO Incentives and Firm Size," Journal of Labor Economics, University of Chicago Press, vol. 22(4), pages 767-798, October.
    28. Robert Parrino & Allen M. Poteshman & Michael S. Weisbach, 2005. "Measuring Investment Distortions when Risk-Averse Managers Decide Whether to Undertake Risky Projects," Financial Management, Financial Management Association, vol. 34(1), Spring.
    29. Yim, Soojin, 2013. "The acquisitiveness of youth: CEO age and acquisition behavior," Journal of Financial Economics, Elsevier, vol. 108(1), pages 250-273.
    30. Rafael La Porta & Florencio Lopez‐de‐Silanes & Andrei Shleifer & Robert W. Vishny, 2000. "Agency Problems and Dividend Policies around the World," Journal of Finance, American Finance Association, vol. 55(1), pages 1-33, February.
    31. Laarni Bulan & Paroma Sanyal, 2011. "Incentivizing managers to build innovative firms," Annals of Finance, Springer, vol. 7(2), pages 267-283, May.
    32. Vicky Henderson, 2002. "Stock Based Compensation: Firm-specific risk, Efficiency and Incentives," OFRC Working Papers Series 2002fe01, Oxford Financial Research Centre.
    33. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
    34. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    35. Morck, Randall & Shleifer, Andrei & Vishny, Robert W., 1988. "Management ownership and market valuation : An empirical analysis," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 293-315, January.
    36. Morck, Randall & Shleifer, Andrei & Vishny, Robert W., 1988. "Management ownership and market valuation," Scholarly Articles 29407535, Harvard University Department of Economics.
    37. Brian J. Hall, 1999. "The Design Of Multi‐Year Stock Option Plans," Journal of Applied Corporate Finance, Morgan Stanley, vol. 12(2), pages 97-106, June.
    38. Milidonis, Andreas & Stathopoulos, Konstantinos, 2014. "Managerial Incentives, Risk Aversion, and Debt," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 49(2), pages 453-481, April.
    39. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    40. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-1199, December.
    41. John, Teresa A & John, Kose, 1993. "Top-Management Compensation and Capital Structure," Journal of Finance, American Finance Association, vol. 48(3), pages 949-974, July.
    42. Liljeblom, Eva & Pasternack, Daniel & Rosenberg, Matts, 2011. "What determines stock option contract design?," Journal of Financial Economics, Elsevier, vol. 102(2), pages 293-316.
    43. O. Ashenfelter & D. Card (ed.), 1999. "Handbook of Labor Economics," Handbook of Labor Economics, Elsevier, edition 1, volume 3, number 3.
    44. John Core & Wayne Guay, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, June.
    45. Giovanni Cerulli, 2011. "ivtreatreg: A new Stata command for estimating binary treatment models with heterogeneous response to treatment under observable and unobservable selection," Italian Stata Users' Group Meetings 2011 04, Stata Users Group.
    46. Palmon, Oded & Bar-Yosef, Sasson & Chen, Ren-Raw & Venezia, Itzhak, 2008. "Optimal strike prices of stock options for effort-averse executives," Journal of Banking & Finance, Elsevier, vol. 32(2), pages 229-239, February.
    47. Graham, John R. & Harvey, Campbell R. & Puri, Manju, 2013. "Managerial attitudes and corporate actions," Journal of Financial Economics, Elsevier, vol. 109(1), pages 103-121.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Liljeblom, Eva & Pasternack, Daniel & Rosenberg, Matts, 2011. "What determines stock option contract design?," Journal of Financial Economics, Elsevier, vol. 102(2), pages 293-316.
    2. Page, T. Beau, 2018. "CEO attributes, compensation, and firm value: Evidence from a structural estimation," Journal of Financial Economics, Elsevier, vol. 128(2), pages 378-401.
    3. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    4. Benson, Bradley W. & Davidson III, Wallace N., 2009. "Reexamining the managerial ownership effect on firm value," Journal of Corporate Finance, Elsevier, vol. 15(5), pages 573-586, December.
    5. Bradley W. Benson & Wallace N. Davidson III & Hongxia Wang & Dan L. Worrell, 2011. "Deviations from Expected Stakeholder Management, Firm Value, and Corporate Governance," Financial Management, Financial Management Association International, vol. 40(1), pages 39-81, March.
    6. James, Hui & Benson, Bradley W. & Wu, Chen (Ken), 2017. "Does CEO ownership affect payout policy? Evidence from using CEO scaled wealth-performance sensitivity," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 328-345.
    7. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
    8. Benson, Bradley W. & Chen, Yu & James, Hui L. & Park, Jung Chul, 2020. "So far away from me: Firm location and the managerial ownership effect on firm value," Journal of Corporate Finance, Elsevier, vol. 64(C).
    9. Jean Canil & Bruce Rosser, 2012. "Australian evidence on CEO option grants," Multinational Finance Journal, Multinational Finance Journal, vol. 16(3-4), pages 225-260, September.
    10. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    11. O'Connor, Matthew L. & Rafferty, Matthew, 2010. "Incentive effects of executive compensation and the valuation of firm assets," Journal of Corporate Finance, Elsevier, vol. 16(4), pages 431-442, September.
    12. Röell, Ailsa & Peng, Lin & Tang, Hongfei, 2016. "CEO Incentives: Measurement, Determinants, and Impact on Performance," CEPR Discussion Papers 11417, C.E.P.R. Discussion Papers.
    13. Pasternack, Daniel & Rosenberg, Matts, 2003. "What Determines Stock Option Contract Design?," Working Papers 498, Hanken School of Economics.
    14. Yaowen Shan & Terry Walter, 2016. "Towards a Set of Design Principles for Executive Compensation Contracts," Abacus, Accounting Foundation, University of Sydney, vol. 52(4), pages 619-684, December.
    15. Bulan, Laarni & Sanyal, Paroma & Yan, Zhipeng, 2010. "A few bad apples: An analysis of CEO performance pay and firm productivity," Journal of Economics and Business, Elsevier, vol. 62(4), pages 273-306, July.
    16. Hongfei Tang, 2014. "Are CEO stock option grants optimal? Evidence from family firms and non-family firms around the Sarbanes–Oxley Act," Review of Quantitative Finance and Accounting, Springer, vol. 42(2), pages 251-292, February.
    17. Loureiro, Gilberto & Makhija, Anil K. & Zhang, Dan, 2011. "Why Do Some CEOs Work for a One-Dollary Salary?," Working Paper Series 2011-7, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    18. Sun, Jerry & Cahan, Steven F. & Emanuel, David, 2009. "Compensation committee governance quality, chief executive officer stock option grants, and future firm performance," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1507-1519, August.
    19. Nanda, Vikram & Onal, Bunyamin, 2016. "Incentive contracting when boards have related industry expertise," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 1-22.
    20. Gao, Huasheng, 2010. "Optimal compensation contracts when managers can hedge," Journal of Financial Economics, Elsevier, vol. 97(2), pages 218-238, August.

    More about this item

    Keywords

    Executive compensation; Exercise prices; Grant size; Option grants; Risk aversion; Moneyness; M52; J33; G32;
    All these keywords.

    JEL classification:

    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:annfin:v:11:y:2015:i:3:p:383-410. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.