Leverage, Volatility and Executive Stock Options

Chongwoo Choe

No a420, Discussion Paper Series from Institute of Economic Research, Hitotsubashi University

Abstract: Leverage, Volatility and Executive Stock Options Abstract This paper studies how an optimal wage contract can be implemented using stock options, and derives the properties of the optimal contract with stock options. Specifically, we show how the exercise price and the size of the option grant should change in respose to changes in exogenous parameter. First, for a fixed exercise price of executive stock options, the size of the option grant decreases in the riskiness of a desired investment policy, decreases in the volatility of return from the risky project, and increases in leverage. Second, for a fixed size of the option grant, the optimal exercise price of managerial stock options increases in the riskiness of a desired investment policy, increases in the volatility of return from the risky project, and decreases in leverage. Several empirical predictions are drawn from these conclusions regarding the pay-performance sensitivity of management compensation.

Keywords: Leverage; volatility; executive stock options; optimal contract (search for similar items in EconPapers)
JEL-codes: D82 G32 J33 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2001-12
Note: Bibliography: p. 21-22
References: Add references at CitEc
Citations: View citations in EconPapers (1)

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https://hermes-ir.lib.hit-u.ac.jp/hermes/ir/re/13851/DP420.pdf

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Journal Article: Leverage, volatility and executive stock options (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:hit:hituec:a420

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