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Stock options and managerial incentives to invest -



Researchers looking to examine the incentive effects of executive stock options are confronted with two immediate challenges. First, standard Black Scholes risk-neutral valuation techniques are inaccurate because executive stock options are not traded, and they are frequently held by managers with undiversified wealth (including human capital) facing short-sale and liquidity constraints.

Second, option values are inextricably linked to executive actions and firm value. If options didn’t affect managerial behavior, and if managerial behavior didn’t affect firm value, then why would firms choose to grant options? The fact that options are a large and growing portion of U.S. executive pay (Murphy, 1999), that firms routinely re-price stock options (Brenner, Sundaram and Yermack, 2000), that largely as a result of stock option pay, U.S. executives, on average, hold a claim on more than 3% of their firms’ shares (Conyon and Murphy, 2000), all these facts suggest that the agency problems between managers and shareholders are large and that the benefits of stock option compensation are potentially great.


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