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Stock Options and Managerial Optimal Contracts

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In this paper we are concerned with the performance of stock option contracts in the provision of managerial incentives. In our simple framework, we restrict the space of contracts available to the principal to those conformed by a fixed payment and a package of call options on the firm's stock. We then offer a characterization of optimal stock option compensation schemes. As compared to the fixed payment and the option grant, we find that the strike price plays an intermediate role in the provision of insurance and incentives. We also develop some efficient algorithms for the computation of optimal contracts in which the observable outcome is drawn from a continuous distribution. These algorithms are useful to address some important issues such as the calibration of a principal-agent model, the degree of risk aversion compatible with current compensation schemes, and the performance of stock option contracts.

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  • Manuel Santos & Jorge Aseff, "undated". "Stock Options and Managerial Optimal Contracts," Working Papers 2133304, Department of Economics, W. P. Carey School of Business, Arizona State University.
    • Handle: RePEc:asu:wpaper:2133304
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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Santos, Manuel S., 1999. "Numerical solution of dynamic economic models," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 5, pages 311-386, Elsevier.
    3. Ivilina Popova & Joseph G. Haubrich, 1998. "Executive compensation: a calibration approach," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(3), pages 561-581.
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    1. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock grants as a commitment device," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2191-2216, November.
    2. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    3. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
    4. Dong, Gang Nathan, 2014. "Excessive financial services CEO pay and financial crisis: Evidence from calibration estimation," Journal of Empirical Finance, Elsevier, vol. 27(C), pages 75-96.
    5. Oscar Mitnik & Qiang Kang, 2008. "Not So Lucky Any More: CEO Compensation in Financially Distressed Firms," Working Papers 0906, University of Miami, Department of Economics.
    6. Scott Fung & Hoje Jo & Shih‐Chuan Tsai, 2009. "Agency problems in stock market‐driven acquisitions," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 8(4), pages 388-430, October.
    7. Arantxa Jarque, 2014. "The Complexity of CEO Compensation," Working Paper 14-16, Federal Reserve Bank of Richmond.
    8. Pirjetä, Antti & Ikäheimo, Seppo & Puttonen, Vesa, 2010. "Market pricing of executive stock options and implied risk preferences," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 394-412, June.
    9. Óscar Gutiérrez & Vicente Salas-Fumás, 2014. "Options in Agency with Binary Uncertainty," Manchester School, University of Manchester, vol. 82(2), pages 218-236, March.
    10. Christopher Armstrong & David Larcker & Che-Lin Su, 2007. "Stock Options and Chief Executive Compensation," Discussion Papers 1447, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    11. Arantxa Jarque, 2008. "Optimal CEO compensation and stock options," Working Papers. Serie EC 2008-04, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    12. Christian Hofmann & Steven Huddart & Thomas Pfeiffer, 2023. "An analysis of net-outcome contracting with applications to equity-based compensation," Review of Accounting Studies, Springer, vol. 28(3), pages 1657-1689, September.

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