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Benefits of Broad-based Option Pay

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  • Inderst, Roman
  • Mueller, Holger

Abstract

Future wage payments drive a wedge between total firm output and the output share received by the firm?s owners, thus potentially distorting strategic decisions by the firm?s owners such as, e.g., whether to continue the firm, sell it, or shut it down. Using an optimal contracting approach, we show that the unique optimal firm-wide employee compensation scheme from this perspective is a broad-based option plan. Broad-based option pay minimizes the firm?s expected future wage payments in states of nature where the firm is only marginally profitable, thus making continuation as attractive as possible in precisely those states of nature where, e.g., a high fixed wage would lead the firm?s owners to inefficiently exit.

Suggested Citation

  • Inderst, Roman & Mueller, Holger, 2005. "Benefits of Broad-based Option Pay," CEPR Discussion Papers 4878, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4878
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    References listed on IDEAS

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    Cited by:

    1. repec:ebl:ecbull:v:10:y:2006:i:2:p:1-8 is not listed on IDEAS
    2. Derek Jones & Panu Kalmi & Mikko Mäkinen, 2010. "The productivity effects of stock option schemes: evidence from Finnish panel data," Journal of Productivity Analysis, Springer, vol. 33(1), pages 67-80, February.
    3. Ingolf Dittmann & Ko-Chia Yu & Dan Zhang, 2017. "How Important Are Risk-Taking Incentives in Executive Compensation?," Review of Finance, European Finance Association, vol. 21(5), pages 1805-1846.
    4. Pukthuanthong, Kuntara & Roll, Richard & Walker, Thomas, 2007. "How employee stock options and executive equity ownership affect long-term IPO operating performance," Journal of Corporate Finance, Elsevier, vol. 13(5), pages 695-720, December.
    5. repec:oup:rfinst:v:21:y:2017:i:5:p:1805-1846. is not listed on IDEAS

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    More about this item

    Keywords

    Broad option pay; Employee stock options;

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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