Abstract
We compare three types of stock options: traditional stock options, market-indexed options, and cost-of-capital indexed options from the firm’s and executive’s perspectives. Applying the traditional and modified Black-Scholes formulae, we find that the cost-of-capital indexed options, in general, have the lowest cost to a company relative to the traditional stock options and market-indexed options. In addition, executives place higher values on the cost-of-capital indexed options than those on the market-indexed options. These options also have higher incentives and are more efficient than the market-indexed options. Especially when managers pay certain amount of money for their options, the differences of both the option values and the incentives between these two indexed options become larger. Key words: Executive compensation, indexed option, incentive effect
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