Optimal Exercise Prices for Executive Stock Options

Brian J. Hall and Kevin Murphy ()

No 7548, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: J0 J3 (search for similar items in EconPapers)
Date: 2000-02
New Economics Papers: this item is included in nep-fin
Note: CF LS PE
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Citations: View citations in EconPapers (135)

Published as American Economic Review, Vol. 90, no. 2 (May 2000): 209-214

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