stock option repricing and its alternatives an empirical examination in this paper i examine the likelihood of ceo stock option repricing and its alternatives namely option grant stock grant and do nothing multinomial logit results suggest that firms reprice options to increase sensitivity of pay to stock price and to temper down sensitivity of pay to volatility moreover repricing firms are younger and more concentrated in industries where human capital is important finally i find no evidence that internal governance or executive conflicts of interest are relevant in explaining repricing my results indicate that repricing is motivated by incentive alignment and retention and not by agency cost considerations

ironing out the kinks in executive compensation linking incentive pay to average stock prices abstract traditional stock option grant is the most common form of incentive pay in executive compensation applying a principal agent analysis we find this common practice suboptimal and firms are better off linking incentive pay to average stock prices among other benefits averaging reduces volatility by about 42 making the incentive pay more attractive to risk averse executives holding the cost of the option grant to the firm constant asian stock options are more cost effective than traditional stock options and provide stronger incentives to increase stock price more importantly the improvement is achieved with little impact on the option grant s risk incentives after adjusting for option cost finally averaging also improves the value and incentive effects of indexed stock options

the dating game do managers designate option grant dates to increase their compensation we provide evidence of two variants of a dating game that entails picking a grant date ex post that is after the board s compensation decision is made back dating picking a date before the board decision date and forward dating waiting after the board decision date to observe the stock price behavior consistent with back dating we find stock return behavior around the grant date to be positively related to reporting lag in the promptly reported sample we find stock return behavior and the pattern of reporting lags consistent with forward dating our calculations show that managers can obtain economically significant benefits by playing the dating game

using auctions to price employee stock options the case of zions bancorporation esoars the first empirical analysis of zions bancorporation s 2006 and 2007 auctions of employee stock option appreciation rights securities esoars this study examined 1 the impact of auction rules on bidding strategies and allocations 2 the efficiency of the auction clearing prices and 3 the value gap between esoars auction clearing prices and various model based estimates it found that the design features of the auctions e g ending rules significantly affected bidding strategies but not final allocations which remained highly concentrated it also found that the clearing prices 1 displayed high price elasticities of demand suggesting efficient price discovery and 2 were low relative to some but not all model based estimates these findings suggest design improvements that might benefit auctions of other illiquid derivatives e g banks troubled assets currently being considered by the u s government

optimal asset allocation and risk shifting in money management this article investigates a fund manager s risk taking incentives induced by an increasing and convex relationship of fund flows to relative performance in a dynamic portfolio choice framework we show that the ensuing convexities in the manager s objective give rise to a finite risk shifting range over which she gambles to finish ahead of her benchmark such gambling entails either an increase or a decrease in the volatility of the manager s portfolio depending on her risk tolerance in the latter case the manager reduces her holdings of the risky asset despite its positive risk premium our empirical analysis lends support to the novel predictions of the model

valuing employee stock options does the model matter in this numerical analysis of models for valuing employee stock options the focus is on the impact of a model on the resulting option prices and the sensitivity of pricing differences between models with respect to changes in the parameters for most models the price reduction relative to standard options is uniquely determined by the expected life of the option in fact with the exception of the financial accounting standards board 123 model pricing differences are negligible if the models are calibrated to the same expected life of the option consequently the application of models with several hard to estimate parameters such as the utility maximizing model can be greatly simplified by calibration because expected life is easier to estimate than utility parameters

exchange traded funds a new investment option for taxable investors exchange traded funds etfs are a new variety of mutual fund that first became available in 1993 etfs have grown rapidly and now hold nearly 80 billion in assets etfs are sometimes described as more tax efficient than traditional equity mutual funds since in recent years some large etfs have made smaller distributions of realized and taxable capital gains than most mutual funds this paper provides an introduction to the operation of exchange traded funds it also compares the pre tax and post tax returns on the largest etf the spdr trust that invests in the s p500 with the returns on the largest equity index fund the vanguard index 500 the results suggest that between 1994 and 2000 the before and after tax returns on the spdr trust and this mutual fund were very similar both the after tax and the pre tax returns on the fund were slightly greater than those on the etf these findings suggest that etfs offer taxable investors a method of holding broad baskets of stocks that deliver returns comparable to those of low cost index funds this abstract was borrowed from another version of this item

stock option repricing heads i win tails you lose recent scandals at enron worldcom and global crossing have put the ethical spotlight on corporate malfeasance as never before however these are the situations in which management knew that they made the wrong choice as professor joseph badaracco of harvard business school points out the real ethical dilemmas arise when people must choose between right and right where both choices can be justified yet one must be chosen over the other whether or not to reprice stock options represents one such ethical dilemma repricing can help exodus of talented employees and motivate them to improve firm performance however it alienates shareholders and other workers of the company who are left unprotected from the adverse economic consequences of a stock price decline

underwater options and the dynamics of executive pay to performance sensitivities we empirically analyze the dynamics of executives pay to performance sensitivities option pay to performance sensitivities become weaker as options fall underwater often leading to pressures to reprice options or restore pay to performance sensitivity in other ways building a detailed data set on executives portfolios of stock and options we find that the responsiveness of pay to performance sensitivities created by all executive holdings of stock and options to changes in stock price is large the elasticity of pay to performance sensitivities with respect to stock price decreases is about 0 7 and is larger for high option executives and for executives with high percentages of options already underwater the dominant mechanism through which companies offset declines in option pay to performance sensitivities is larger option grants following stock price declines on average these larger grants restore approximately 40 of the stock price induced pay to performance sensitivity declines option repricings are inconsequential in this regard despite the attention they have attracted in looking at positive returns we find the reverse higher returns both directly increase pay to performance sensitivities and lead to larger option grants which raise pay to performance sensitivities further thus option grants to executives tend to be largest following large stock price increases or large stock price decreases

paper millionaires how valuable is stock to a stockholder who is restricted from selling it abstract many firms have stockholders who face severe restrictions on their ability to sell their shares and diversify the risk of their personal wealth we study the costs of these liquidity restrictions on stockholders using a continuous time portfolio choice framework these restrictions have major effects on the optimal investment and consumption strategies because of the need to hedge the illiquid stock position and smooth consumption in anticipation of the eventual lapse of the restrictions these results provide a number of important insights about the effects of illiquidity in financial markets

revisiting the incentive effects of executive stock options abstract we develop a multiperiod framework to evaluate the incentive effects of executive stock options esos for a given increase in the grant date firm stock price and a concurrent increase in return volatility the increment of total value at the vesting date acts as a proxy for the incentive effects of esos if the option is attached to the existing contract without adjusting cash compensation we suggest that a firm should not always fix the strike price to the grant date stock price instead the strike price should vary with the length of the vesting period we also show that compared with at the money options restricted stock generates greater incentives to increase stock prices in some scenarios especially when equity based awards are vested early if the vesting period is long the firm could grant options instead of restricted stock to maximize incentives

leverage decision and manager compensation with choice of effort and volatility abstract we study the incentive effects of granting levered or unlevered stock to a risk averse manager the stock is granted by risk neutral shareholders who choose leverage and compensation level the manager applies costly effort and selects the level of volatility both of which affect expected return the results are driven by the attempt of the risk neutral shareholders to maximize the value of their claims net of the compensation package we consider a dynamic setting and find that levered stock is optimal for high type managers firms with high momentum large firms and firms for which additional volatility only implies a modest increase in expected return

liquidity risk and exchange traded fund returns variances and tracking errors abstract we investigate the effect of exchange traded fund etf liquidity on etf tracking errors returns and volatility in the us we find that illiquid etfs have large tracking errors the effect is more pronounced when underlying assets are less liquid returns and liquidity of illiquid etfs are more sensitive to underlying index returns or etf market liquidity or both thus a positive liquidity premium exists in us etf markets the etf variance could be larger than its net asst value variance owing to infrequent trading in summary illiquid etfs are more likely to deviate from their underlying indexes and could be riskier than underlying portfolios

the timing of option repricing we investigate whether executive stock option repricings are systematically timed to coincide with favorable movements in the company s stock price for a sample of 236 repricing events we observe sharp increases in stock price in the 20 day period following the repricing date in addition repricing dates tend to either precede the release of good news or follow the release of bad news in the quarterly earnings announcements since information about stock option repricing is not generally released to the public around the repricing date these findings suggest that ceos opportunistically manage the timing of the option repricing date

incentive design under loss aversion compensation schemes often reward success b ut do not penalize failure fixed salaries with stock options or bonuses have this feature yet the standard principal agent model implies that pay is normally monotonically increasing in performance this paper shows that under loss aversion there will be intervals over which pay is insensitive to performance with the use of carrots but not sticks is frequently optimal especially when risk aversion is low and reference income is e ndogenous a further benefit of capping losses for example through options is to discourage reckless behavior by executives seeking to resurrect their fortunes jel f3 f4

work hard not smart stock options in executive compensation abstract this paper examines the optimal equity compensation for executives when executives choose a level of effort to devote to gathering information and a criterion for acting on the information gathered the optimal exercise price involves a trade off a higher exercise price moves the executive s decision criterion away from first best but provides leverage that moves the executive s effort toward first best this trade off depends on a variety of factors including the potential influence of decisions on firm value we document empirical regularities consistent with the theory such as that options are relatively less prevalent in the equity compensation of more senior executives

managers compensation and misreporting a costly state verification approach i introduction the use of stock options in compensation packages as a way of providing the firm management with the right incentives has been quite popular in the 1990s the favor encountered by options started however to decrease in the past few years the decline in the use of option grants in top executives compensation packages occurred mainly as a reaction to the recent accounting scandals which has prompted the design of alternative stock based compensation schemes e g restricted stock grants or indexed options as reported by hall and murphy 2003 the grant date value of options assigned to all employees of an average standard poor s 500 firm measured in millions of 2002 constant us increased from 22 in 1992 to 238 in 2000 and subsequently decreased to 141 in 2002 although percentages varied from year to year the ceos share of the total grant has fallen from about 7 in the mid 1990s to less than 5 in 2000 2002 1 the decline in the use of options for top management is widely confirmed according to a pearl meyer partners study for the new york times stock option grants that accounted for 52 of the pay of the average ceo of a major company in 2002 were down to an estimated 35 in 2003 a recent watson wyatt report states that the value of new stock option awards granted to ceos at large companies fell by nearly 60 between 2001 and 2003 with the average value of new stock option grants declining from us 10 2 million in 2001 to us 4 2 million in 2003 the decline in options has been softened by the sharp increase in restricted stock grants and other long term incentive award values 2 in this paper we aim to reevaluate the role of stock options as an ingredient of top management compensation packages able to align the interests of managers and shareholders avoiding misreporting of the firm value at the same time 3 in a costly state verification csv model with moral hazard we show that incentive compatible contracts inducing both incentive alignment and truthful revelation of the firm value must entail a strictly convex compensation schedule that is a fixed payment wage when the firm value is sufficiently low and a state contingent claim increasing in the firm value otherwise a simple and commonly observed way to achieve a convex compensation scheme is to design a remuneration including a fixed wage and a call option on the firm equity as we will show such remuneration allows on the one hand to preserve top management incentives providing for a compensation increasing in equity value and on the other hand to reduce the verification costs that must be incurred to avoid misreporting as verification is not needed in the region where the remuneration is fixed 4 options are by no means the only way to achieve a convex compensation however many other schemes having otherwise desirable properties over options do not have the convex shape discussed above for instance combining a fixed wage with restricted stock grants defines a compensation linearly increasing in the firm s equity value which does not allow to reduce misreporting verification costs that always have to be sustained in this case using an incentive compatible compensation scheme fixed wage plus call options we characterize the contract offered by the firm under the assumption of a deterministic and perfect audit technology showing that for any given value of the option package the manager should receive the largest possible number of options at the highest strike price allowing shareholders to reduce the expected verification cost furthermore the strike price of the option turns out to be determined by incentive compatibility i e the option value must be such that the manager is induced to exert the desired level of effort while the magnitude of the fixed wage is defined by individual rationality there are three main policy implications of our analysis

optimal exercise prices for executive stock options although exercise prices for executive stock options can be set either below or above the grant date market price in practice virtually all options are granted at the money we offer an economic rationale for this apparent puzzle by showing that pay to performance incentives for risk averse undiversified executives are typically maximized by setting exercise prices at or near the grant date market price we provide an operationally useful alternative to black scholes 1973 for the purpose of both valuing executive stock options and measuring the incentives created by options our framework has implications not only for exercise price policies but also for indexed options option repricings exchanges of cash for stock based compensation and the design of bonus plans

are ceos really paid like bureaucrats a common view is that there is little correlation between firm performance and ceo pay using a new fifteen year panel data set of ceos in the largest publicly traded u s companies we document a strong relationship between firm performance and ceo compensation this relationship is generated almost entirely by changes in the value of ceo holdings of stock and stock options in addition we show that both the level of ceo compensation and the sensitivity of compensation to firm performance have risen dramatically since 1980 largely because of increases in stock option grants

inefficiencies in the pricing of exchange traded funds the prices of exchange traded funds etfs can deviate significantly from their net asset values navs in spite of the arbitrage mechanism that allows authorized participants to create and redeem shares for the underlying portfolios the deviations typically within a band of about 200 bps are larger in funds holding international or illiquid securities to control for stale pricing of the underlying assets i introduce a novel approach that uses the cross section of prices on a group of similar etfs the average pricing band remains economically significant at about 100 bps with even larger mispricings in some asset classes active trading strategies exploiting such inefficiencies produce substantial abnormal returns before transaction costs providing further proof of short term mean reversion in etf prices

pricing executive stock options under employment shocks abstract we obtain explicit expressions for the subjective objective and market value of perpetual executive stock options esos under exogenous employment shocks driven by an independent poisson process previously we obtain the executive s optimal exercise policy from the subjective valuation that is necessary for the objective one or fair value the perpetual eso is compared with the true finite maturity eso finding that the approximation is reasonably good to illustrate the usefulness of the objective valuation for accounting purposes we analyze the statistical distribution of the fair value when there is uncertainty about the employment shock intensity finally the role of esos in the design of executives incentives is also discussed

stock option grants to target ceos during private merger negotiations abstract unscheduled stock options to target chief executive officers ceos are a nontrivial phenomenon during private merger negotiations in 920 acquisition bids during 1999 2007 over 13 of targets grant them these options substitute for golden parachutes and compensate target ceos for the benefits they forfeit because of the merger targets granting unscheduled options are more likely to be acquired but they earn lower premiums consequently deal value drops by 62 for every dollar target ceos receive from unscheduled options conversely acquirers of targets offering these awards experience higher returns therefore deals involving unscheduled grants exhibit a transfer of wealth from target shareholders to bidder shareholders

how index trading increases market vulnerability the authors found that the rise in popularity of index trading assets invested in index funds reached more than 1 trillion at the end of 2010 contributes to higher systematic equity market risk more equity index trading corresponds to increased cross sectional trading commonality which precipitates higher return correlations among stocks consistent with the accelerating growth of passive trading the authors found that equity betas have not only risen but also converged in recent years

private information in executive stock option trades evidence of insider trading in the uk uk executives stock option exercises and associated sell decisions are motivated by private inside information executives use their inside information to lock in short term gains and to sell stock acquired prior to negative abnormal stock returns this informed trading is robust to the alternative factors that might motivate the exercise of executive stock options including option moneyness and value of exercise we suggest that the disparity in informed trading between us and uk executives option trades is related to important differences in the proportion of executive remuneration linked to options the regulation of options and the taxation of option gains

executive option repricing incentives and retention while many firms grant executive stock options that can be repriced other firms systematically restrict or prohibit repricing this article investigates the determinants of firms repricing policies and the consequences of such policies for executive turnover and retention firms that have better internal governance that use more powerful stock based incentives or that face less shareholder scrutiny are more likely to maintain repricing flexibility firms that restrict repricing are more vulnerable to voluntary executive turnover following stock price declines when share price declines are severe restricting firms appear to award unusually large numbers of new options the past several years have witnessed tremendous growth in the use of stock options to compensate corporate executives indeed virtually all of the largest publicly traded u s firms now rely on stock option plans and option grants constitute more than half of the annual pay for chief executive officers murphy 1999 a natural consequence of this growth has been an increasing awareness and sophistication among academics practitioners and the popular press about how the design and administration of option plans can help to enhance or destroy shareholder value although a number of corporate practices pertaining to executive options have elicited controversy perhaps no such practice has been more controversial than repricing which involves effectively lowering the exercise prices of previously granted options on the one hand firms often describe repricing as a useful means for restoring incentives and retaining executive talent and most stock option plans currently in existence permit repricing on the other hand shareholders and institutional investors have voiced intense opposition to the practice on the grounds that it apparently rewards managers for poor performance for instance the council of institutional investors an organization of pension funds controlling over 1 5 trillion in assets has adopted a policy statement calling on companies to restrict repricing according to ann yerger director of research at the council member funds generally detest

lower salaries and no options on the optimal structure of executive pay we estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 us ceos the model is widely used in the compensation literature but it predicts that almost all of the ceos in our sample should hold no stock options instead ceos should have lower base salaries and receive additional shares in their companies for a typical value of relative risk aversion almost half of the ceos in our sample would be required to purchase additional stock in their companies from their private savings the model predicts contracts that would reduce average compensation costs by 20 while providing the same incentives and the same utility to ceos we investigate a number of extensions and modi cations of the standard model but nd none of them to be satisfactory we conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts one reason may be that executive pay contracts are suboptimal

on the perils of financial intermediaries setting security prices the mutual fund wild card option economic distortions can arise when financial claims trade at prices set by an intermediary rather than direct negotiation between principals we demonstrate the problem in a specific context the exchange of open end mutual fund shares mutual funds typically set fund share price nav using an algorithm that fails to account for nonsynchronous trading in the fund s underlying securities this results in predictable changes in nav which lead to exploitable trading opportunities a modification to the pricing algorithm that corrects for nonsynchronous trading eliminates much of the predictability however there are many other potential sources of distortion when intermediaries set prices copyright the american finance association 2001

too much of a good incentive the case of executive stock options abstract using a utility maximization framework i show that the incentive to increase stock price does not always increase as more options are granted keeping the total cost of his compensation fixed granting more options creates greater incentives to increase stock price only if option wealth does not exceed a certain fraction of total wealth beyond this critical level granting more options actually reduces incentive effects and becomes counterproductive in addition stock options also create incentive to reduce increase idiosyncratic systematic risk these incentive effects are sensitive to the choice of exercise price

optimal strike prices of stock options for effort averse executives abstract this paper evaluates the common practice of setting the strike prices of executive option plans at the money hall and murphy hall brian murphy kevin j 2000 optimal exercise prices for executive stock options american economic review 90 2 209 214 claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance however they do not incorporate effort and the possibility that managers are effort averse into their model we revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages options and stock grants we simulate the manager s effort choice and compensation as well as the value of shareholders equity under alternative compensation schemes and identify schemes that are optimal our simulations indicate that when abstracting from tax considerations it is optimal to award managers with options that will most likely be highly valuable i e substantially in the money on their expiration date prior to 2006 the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006

valuing environmental factors in cost benefit analysis using data envelopment analysis abstract environmental cost benefit analysis ecba is used for the social evaluation of investment projects and policies that involve significant environmental impacts economic valuation of environmental impacts forms one of the critical steps of ecba we develop a new method for this purpose which does not require price estimation for environmental impacts using stated or revealed preference methods our approach is based on data envelopment analysis dea which is modified to ecba by using absolute shadow prices instead of relative prices we also discuss how the method can be used for sensitive analysis in ecba we illustrate the method by means of a hypothetical numerical example

ceo incentives and firm size we develop a model that clarifies how to measure ceo incentive strength and how to reconcile the enormous differences in pay sensitivities between executives in large and small firms the crucial parameter is shown to be the elasticity of ceo productivity with respect to firm size we find that ceo marginal products rise significantly with firm size confirming rosen s conjecture that ceos of large firms have a chain letter effect on firm performance and overall ceo incentives are roughly constant or decline slightly with firm size we employ a multitask model to discuss implications for the design of control systems

are politicians really paid like bureaucrats abstract we provide the first empirical analysis of gubernatorial pay using u s data for 1950 90 we document substantial variation in the wages of politicians both across states and over time gubernatorial wages respond to changes in state income per capita and taxes we estimate that governors receive a 1 percent pay cut for each 10 percent increase in per capita tax payments and a 4 5 percent increase in pay for each 10 percent increase in income per capita in their states there is evidence that the tax elasticity reflects a form of reward for performance the evidence for the income elasticity of pay is less conclusive but is suggestive of rent extraction motives finally we find that democratic institutions play an important role in shaping pay for example voter initiatives and the presence of political opposition significantly reduce the income elasticity of pay and increase tax elasticities of pay

executive compensation a modern primer this article studies traditional and modern theories of executive compensation bringing them together under a simple unifying framework accessible to the general interest reader we analyze assignment models of the level of pay and static and dynamic moral hazard models of incentives and compare their predictions to empirical findings we make two broad points first traditional theories find it difficult to explain the data suggesting that compensation results from rent extraction by ceos however more modern shareholder value theories that arguably better capture the ceo setting do deliver predictions consistent with observed practices suggesting that these practices need not be inefficient second seemingly innocuous features of the modeling setup often made for tractability or convenience can lead to significant differences in the model s implications and conclusions on the efficiency of observed practices we close by highlighting apparent inefficiencies in executive compensation and additional directions for future research