Estimating the Cost of Executive Stock Options: Evidence from Switzerland

Wolfgang Drobetz, Pascal Pensa and Markus Schmid

Working papers from Faculty of Business and Economics - University of Basel

Abstract: It is often argued that Black-Scholes (1973) values overstate the subjective NEWLINE value of stock options granted to risk-averse and under-diversified executives. NEWLINE We construct a "representative" Swiss executive and extend the certainty- NEWLINE equivalence approach presented by Hall and Murphy (2002) to assess NEWLINE the value-cost wedge of executive stock options. Even with low coefficients NEWLINE of relative risk aversion, the discount can be above 50% compared to the NEWLINE Black-Scholes values. Regression analysis reveals that the equilibrium level NEWLINE of executive compensation is explained by economic determinant variables NEWLINE such as firm size and growth opportunities, whereas the managers' pay-forperformance NEWLINE sensitivity remains largely unexplained. Firms with larger NEWLINE boards of directors pay higher wages, indicating potentially unresolved NEWLINE agency conflicts. We reject the hypothesis that cross-sectional differences in NEWLINE the amount of executive pay vanish when risk-adjusted values are used as NEWLINE the dependent variable.

Keywords: Managerial compensation; incentives; executive stock options; option valuation; risk aversion (search for similar items in EconPapers)
JEL-codes: G13 G32 J33 (search for similar items in EconPapers)
Date: 2007-10-01
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bsl:wpaper:2007/17

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