Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management

Jens Jackwerth () and James Hodder

No 08-07, CoFE Discussion Paper from Center of Finance and Econometrics, University of Konstanz

Abstract: We model a firm’s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also dynamically controls allocation of his outside wealth. We explore interactions between those controls as he partially hedges his exposure to firm risk. Conditioning on his optimal behavior, control of firm risk increases the expected time to exercise for his employee stock options. It also reduces the percentage gap between his certainty equivalent and the firm’s fair value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile.

New Economics Papers: this item is included in nep-bec and nep-upt
Date: 2008-02-25
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Working Paper: Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management (2008)
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