The Relationship Between Executive Stock Options Compensation and Firm Value

Abstract

The objective of this study is to provide a basic and direct empirical investigation into the impact of executive stock options on the value of the firm. In order to achieve this, we investigate the relationship between measures of stock option values and earnings. We also examine the impact of executive stock options on the firm's cost of capital using the firm's earnings volatility and probability of bankruptcy as proxies, thus providing evidence on the impact of executive stock options on both the primary components of firm value which include earnings and cost of discounting the earnings. The findings show that using executive stock options could have positive impact on the value of the firm, as reflected in the coefficient significance of the Black-Scholes measure of stock options on the reported operating income as well as nondiscretionary earnings. The empirical evidence on the proxy for the cost of capital, i.e. probability of bankruptcy using Altman (1968) Z-Score, also reinforces these findings. The results from this study contribute to the literature on executive stock options compensation.