Executive Stock Options Research Articles

Executive Stock Option Exercise with Full and Partial Information on a Drift Change Point

We analyze the optimal exercise of an American call executive stock option (ESO) written on a stock whose drift parameter falls to a lower value at a change point, an exponentially distributed random time independent of the Brownian motion driving the stock. Two agents, who do not trade the stock, have differing information on the change point and seek to optimally exercise the option by maximizing its discounted payoff under the physical measure. The first agent has full information and observes the change point. The second agent has partial information and filters the change point from price observations. This scenario is designed to mimic the positions of two employees of varying seniority, a fully informed executive and a partially informed less senior employee, each of whom receives an ESO. The partial information scenario yields a model under the observation filtration $\widehat{\mathbb{F}}$ in which the stock drift becomes a diffusion driven by the innovations process, an $\widehat{\mathbb{F}}$-Brownian motion also driving the stock under $\widehat{\mathbb{F}}$, and the partial information optimal stopping value function has two spatial dimensions. We rigorously characterize the free boundary PDEs for both agents, establish shape and regularity properties of the associated optimal exercise boundaries, and prove the smooth pasting property in both information scenarios, exploiting some stochastic flow ideas to do so in the partial information case. We develop finite difference algorithms to numerically solve both agents' exercise and valuation problems and illustrate that the additional information of the fully informed agent can result in exercise patterns which exploit the information on the change point, lending credence to empirical studies which suggest that privileged information of bad news is a factor leading to early exercise of ESOs prior to poor stock price performance.

The Valuation of Executive Stock Option Using the Integral Representation Method

This study derives a closed-form approximate solution for Bermudan reset executive stock options with cash dividends. The complicated payoff characteristic of this exotic option is caused by its particular stylistic features, including the reset mechanism, cash dividends, early exercises, and increasing volatilities. Using the integral representation method, a closed-form approximate solution was successfully derived. Moreover, this study discusses how specific critical factors affect executive stock option values and arrives at some interesting results by way of a numerical calibration.

Expensing Performance-Vested Executive Stock Options: Is There Underreporting Under IFRS 2?

This study generates new empirical evidence on the issue of underreporting of executive stock options. It is the first to investigate this issue under the mandatory expense setting created by International Financial Reporting Standard (IFRS) 2. I use a hand-collected data sample from Germany, where stock options have a long history of performance vesting, which allows me to analyze the added potential to manipulate values through the more complex valuation methods found in Germany. I find that many firms fail to disclose all required parameters; this failure is linked to incentives to hide remuneration and lack of experience in preparing IFRS reports. For reporting firms, I show that underreporting exists in Germany despite a new enforcement framework, and that it is driven by incentives to hide higher values. This holds implications for both investors who may want to institute stricter supervision as well as enforcement agencies, who should pay more attention to reporting of option-based compensation.

Expensing performance-vested executive stock options: is there underreporting under IFRS 2?

This study generates new empirical evidence on the issue of underreporting of executive stock options. It is the first under the mandatory expense setting of International Financial Reporting Standard (IFRS) 2 and to include performance-vested options. I use a hand-collected data sample from Germany, where performance vesting has a longer history than in other countries. I find that many firms fail to disclose all required parameters and underreport the values of the options. Besides inexperience with preparing IFRS reports, incentives to hide higher pay are associated with this reporting behavior. Additionally, firms with more complex options underreport more. Since the German setting shares many institutional similarities with other (European) IFRS countries, the results are of interest to shareholders, standard setters, and enforcement authorities in such countries.

Management compensation contracts and distribution policies in the US technology sector

This paper examines the impact of executive compensation practices on (a) the decision to distribute and (b) the distribution channel employed by companies from the US technology sector. We report that firms that compensate their managers using executive stock options (ESOs) tend to distribute less and firms that use stock awards make more distributions. When we simultaneously examine the distribution and the channel used, we find firms using ESOs restrict their dividend payments but their propensity for stock repurchases is unaffected. Firms using stock awards to compensate managers make greater distributions across all channels. We also provide strong evidence in favour of the agency and leverage explanations for distributions.

Pricing executive stock options with averaging features under the Heston–Nandi GARCH model

AbstractIn this paper, we focus on the pricing issue of four types of executive stock options (ESOs) in the Heston–Nandi generalized autoregressive conditional heteroskedasticity option pricing model. Based on the derived benchmark strike prices in the proposed framework, we obtain the closed‐form pricing formulae for four types of ESOs. In the numerical part, we investigate the sensitivity and cost efficiency of ESOs and suggest that systematic risk (stock β) and the fraction of wealth invested in restricted stock could impede the cost efficiency of ESOs.

An Empirical Study on the Economic Characteristics of Firms Granting Stock Options

기업들은 대리인문제 완화와 기업지배구조 개선을 통한 기업가치 향상을 위한 인센티브제도로서 경영자 스톡옵션을 활용하고 있다. 본 연구의 목적은 경영자 스톡옵션 부여기업들의 특성을 실증적으로 분석하는 것이다. 이를 위하여 2002년부터 2017년까지 16년간 한국거래소 KOSPI와 KOSDAQ에 계속 상장된 839개 제조업 기업들의 재무제표를 이용하여 panel logit 모형을 추정하고 그 결과를 분석하였다. 본 연구에서 얻은 주요 결과는 다음과 같다. 첫째, KOSDAQ 소속기업과 중소기업들은 대리인비용의 대리변수인 매출액영업비용율과 영업현금흐름비율이 증가할수록 스톡옵션제도를 적극적으로 활용하였다. 대리인문제를 완화하기 위한 인센티브제도로 스톡옵션을 활용하기 때문이라고 생각된다. 둘째, 지배주주지분율은 음(-)의 유의한 영향을 미치는 것으로 나타났는데, 이는 지배주주의 지분율이 높을수록 경영자를 감시하기가 용이하여 스톡옵션 활용의 필요성이 줄어들기 때문이라고 추론된다. 셋째, 외국인지분율은 KOSDAQ 기업과 대기업 경우에서 양(+)의 유의한 영향을 미치는 것으로 나타났는데, 이는 외국인투자자들이 경영투명성을 높이고 대리인비용을 줄이기 위한 목적으로 스톡옵션제도를 적극 활용하기를 원하기 때문이라고 생각된다. 넷째, KOSPI 기업과 대기업 경우에서 기업규모가 음(-)의 유의한 영향을 미치는 것으로 나타났지만, 중소기업 경우에는 기업규모가 양(+)의 유의한 영향을 미치는 것으로 나타났다.Companies are using executive stock options as an incentive system to improve corporate value through easing agency problems and improving corporate governance. The purpose of this study is to empirically analyze the characteristics of firms which take advantage of executive stock options. For this purpose, the financial statements of 839 manufacturing companies that were listed on KOSPI and KOSDAQ for 16 years from 2002 to 2017 are utilized, and the results were estimated and analyzed with panel logit model. The main results obtained in this study are as follows. First, KOSDAQ companies and small-sized companies actively utilized the stock option system as selling, general, and administrative cost ratio and free cash flow to sales ratio, which are the proxy variables of agent cost. This implies that stock options are used as incentive plans for reducing agency cost. Second, it can be concluded that the controlling shareholder’s ratio has a negative effect on stock options. Third, foreign investors’ ratio has a positive(+) effect on stock options in KOSDAQ and big-sized firms. This means that foreign investors want to utilize the stock option system in order to increase management transparency and reduce agency cost. Fourth, while KOSPI and big-sized companies have a negative effect on firm size, small-sized firms have a positive effect on firm size.

Information, Insider Trading, Executive Reload Stock Options, Incentives, and Regulation

We introduce a theoretical model of executives with insider information who receive executive stock options (ESOs) as incentives and optimize their “outside wealth” portfolios. We show that insider information nullifies ESO incentivizing, misaligning executives’ and shareholders’ interests. We offer realigning methods: granting executives with reload stock options (RSOs) while imposing a blackout trading period. Effective blackouts keep executives incentivized without over-restricting, i.e., reducing executives’ welfare below that of outsiders. We introduce RSO pricing for insider executives and offer policy implications: reestablishing the currently “out of favor” RSOs, allowing firms, not regulators, to set effective blackouts on securities they issue.

Asymptotic behavior of optimal exercise strategy for a small number of executive stock options

Abstract We investigate the asymptotic behavior, as the number of options approaches zero, of the optimal exercise strategy of continuous-exercise perpetual executive stock options. Here the optimal strategy is described in terms of the free boundary of a degenerate variational inequality. To our knowledge, our method based on the convexity of the variational inequality at the initial time is new. Also, the unique formal asymptotic expansions of the free boundary and the solution of the variational inequality are derived.

Corporate governance and conglomerate diversification strategy – evidence from Vietnam

PurposeThe purpose of this paper is to examine the impact of internal corporate governance mechanisms, including interest alignment and control devices, on the unrelated diversification level in Vietnam. Additionally, the moderation of free cash flow (FCF) on these relationships is also tested.Design/methodology/approachThe study is based on a balanced panel data set of 70 listed companies in both stock markets, Ho Chi Minh Stock Exchange and Hanoi Stock Exchange, in Vietnam for the years 2007–2014, which gives 560 observations in total.FindingsThe results show that if executive ownership for CEOs is increased, then the extent of diversification is likely to be reduced. However, the link between unrelated diversification level and executive stock option, another interest alignment device, cannot be confirmed. Among three control devices (level of blockholder ownership, board composition and separation of CEO and chairman positions), the study finds a positive connection between diversification and blockholder ownership, and statistically insignificant relations between the conglomerate diversification level and board composition, or CEO duality. Additionally, this study discovers a negative link between diversification and state ownership, although there is no evidence to support the change to the effect of each internal corporate governance mechanism on the diversification level of a firm between high and low FCF.Practical implicationsThe research can be a useful reference not only for investors and managers but also for policy makers in Vietnam. This study explores the relationship among corporate governance, diversification and firm value in Vietnam, where the topics related to effectiveness of corporate governance mechanisms to public companies has been increasingly attractive to researchers since the default of Vietnam Shipbuilding Industry Group (Vinashin) happened in 2010 and the Circular No. 121/2012/TT-BTC on 26 July 2012 of the Vietnamese Ministry of Finance was issued with regulations on corporate governance applicable to listed firms in this country.Originality/valueThis research, first, enriches current literature on the relationship between corporate governance and firm diversification. It can be considered as a contribution to the related topic with an example of Vietnam, a developing country in Asia. Second, the research continues to prove non-unification in results showing the relationship between corporate governance and conglomerate diversification among different nations. Third, it provides a potential input for future research works on the moderation of FCF to the effects of corporate governance on diversification.

The effect of executive stock option delta and vega on the spin-off decision

We investigate the role of CEO incentives around asset restructuring known as corporate spin-off. More specifically, we focus on executive stock option delta and vega vis-à-vis changes in firm value and firm riskiness in response to the corporate spin-off. Controlling for self-selection of the spin-off decision, we find that executive stock option vega is positively related to changes in firm value as well as changes in firm risk. Conversely, we find that executive stock option delta is negatively related to changes in firm value and firm risk. Finally, we estimate the Fazzari et al. (1988) investment model and show that at the business segment level, CEO incentives are positively linked to capital spending. Overall, our study extends the current literature by documenting the role of executive stock option delta and vega in the context of corporate spin-offs.

Moderating Effects of Agency Problems and Monitoring Systems on the Relationship between Executive Stock Option and Audit Fees: Evidence from Korea

Since executive stock options may give rent-seeking incentives to CEOs, CEOs with stock options are likely to misallocate corporate resources to seek personal gains, which in turn may lead to a decrease in firm value. High-quality audit services can reduce the negative impacts of executive stock options on firm value and help firms to ensure sustainable growth. However, while most of the existing accounting literature related to executive stock options (ESO) is mainly focused on earnings management, there are relatively few studies that investigate the relation between ESO and audit fees. At the same time, while previous studies on ESO have been conducted in advanced countries, few studies have identified the relationship between ESO and audit fees in emerging markets. Therefore, it is necessary to examine the effect of ESO under circumstances different from those of developed countries. To fill this gap, we investigated the association between executive stock options and audit fees and examine the moderating effects of agency problems and monitoring systems on the relationship. Using 462 observations from 110 nonfinancial Korean listed companies, for the period of 2000 to 2005, we found that executive stock options are positively related to audit fees. In addition, we found that the effects of executive stock options on audit fees are even higher in firms with high agency problems, effective internal monitoring systems, and major accounting firms. This study can help regulatory agencies to validate audit fee regulations, such as the International Standard on Auditing, that consider ESO a significant risk factor. In addition, these results can help external auditors to set up the specific guidelines for pricing audit fees. Furthermore, the results of this study will contribute to the construction of more desirable corporate governance structure in Korean companies, which in turn would not only enhance firm value but also strengthen the sustainability of companies belonging to the emerging markets.

EXECUTIVE STOCK OPTION PLANS: UJI PENGELOLAAN LABA SELAMA VESTING PERIOD

This study examine earnings management behavior related to compensation in the form of stock options during implementation of the grant program (vesting period). The study also examine and identify the differences in behavior during the execution of stock options. Companies as a sample in this study is a company listed in the Indonesia Stock Exchange, which has adopted the Executive Stock Option Plan and restricted to the companies that publish financial statements as of December 31 for the year 2007 to 2009. Final sample of this research into as many as 21 sample companies and the number of observations are 63 observational studies. The result of testing H1 shows that the more stock options offered to employees, the managers more motivated to manage earnings down prior to offering stock options. The results are consistent with previous studies of the behavior of managers who expect the share price decline before the date of grant, so the manager to pay compensation for stock options with a relatively cheap price. The results of testing H2a and H2b show that the more stock options offered to employees, the managers more motivated to manage earnings upward after offering stock options. Results show that an early stage implementation of executive stock option plans, executives trend to behave increasing income until vesting period final

Is the Agency Assumption Valid for Public Corporations?

Friedman (1970) stated that CEOs of public corporations are the agents of shareholders, which we refer to as the ‘agency assumption.’ Jensen and Meckling (1976) modeled Friedman’s agency assumption, popularizing it among academics. However, in the mid-1970s, the academic consensus was that the agency assumption had little predictive validity in that CEOs did not generally maximize profits for shareholders (Fama & Miller 1972; Jensen & Walkling 2010). Post-1990s the prescriptive validity of the agency assumption improved with the widespread adoption of executive stock option pay. The purpose of this paper is to determine whether the agency assumption is descriptively and prescriptively valid.

The Effects of Stock Option Compensation on R&D Investment in Korea: Exporting vs. Domestic-market Firms

This study investigates the effects of executive stock options and export activities by firms in Korea on their research and development (R&D) investments which are intended to intensify their market competitiveness. We use 63,495 firm-level data of 12,382 firms provided by Microdata Service System (MDSS) of the Korean Bureau of Statistics from 2007 to 2012 using fixed effects panel regression analyses. We find that executive stock options have positive effects on R&D investment, although their effects are either negative or insignificant at best for firms with high-level R&D or exports, and in the manufacturing industry. Moreover, results revealed that exports also have positive effects on R&D investments in general, while the exports of firms in manufacturing, high-level R&D or exports do not affect the R&D investments positively for sustainable growth. The positive effects of executive stock options support the findings of prior studies of Cheng (2004) and Ryan and Wiggins (2002) in general, while negative effects for many types of firms with high-level exports, high R&D activities or in manufacturing industries contradict those of prior studies.

The Effects of Executive Stock Option and Employee Stock Option on the Stock Returns in China

The Effects of Executive Stock Option and Employee Stock Option on the Stock Returns in China

The Effect of Shareholder Rights and Information Asymmetry on Stock-Option-Related Repurchase Activity

As stock-option holdings increase, managers alter their firms’ payout composition, choosing stock repurchases rather than dividends to return cash to shareholders. Prior research presents two competing explanations for this behavior: the flexibility hypothesis and the shareholder power hypothesis. In support of the flexibility hypothesis, I document that this executive stock-option incentive to repurchase stock as a substitute for dividends is stronger when firms have weak shareholder rights and when information asymmetry is severe. In addition, I find that option-induced repurchases are associated with lower shareholder wealth when shareholder rights are weak or when information asymmetry is high. These firms also perform worse in the following year but show higher total payouts to shareholders. Overall, this paper provides a comprehensive picture of managers’ option-driven repurchase behavior.

CEO risk‐taking incentives and relative performance evaluation

AbstractThis paper examines how changes in CEO risk‐taking incentives are associated with changes in the use of relative performance evaluation (RPE) in CEO contracts. Using a shock to the accounting for executive stock options (FAS 123R), I confirm that risk‐taking incentives and option grants declined following FAS 123R using a within‐firm design, but not a within‐CEO‐firm design. Decreased risk‐taking incentives lead executives to invest in projects with lower systematic risk and can result in reduced incentives to hedge exposure to systematic risk in CEO compensation contracts via RPE. However, CEO relative risk aversion increases with decreases in risk‐taking incentives, potentially increasing incentives to protect CEO wealth from systematic performance via RPE. Testing these competing predictions, I find modest evidence consistent with reduced RPE surrounding FAS 123R, suggesting that when CEO risk‐taking incentives are reduced, so are incentives to shield CEO pay from systematic performance.

Backdating of executive stock options: comparing financial and nonfinancial industries

PurposeThe 2008-2009 subprime mortgage crisis in the USA caused bankruptcies and closures of many financial institutions. Yet many CEOs of US financial institutions were awarded huge bonuses and pay packages despite the economic collapse, suggesting that their incomes were not in conjunction with those of the shareholders, indicating a serious agency problem. This issue raises the question as to whether stock option backdating, another example of an agency problem, was as prevalent as slack lending policies among these financial institutions. This paper aims to compare the relative magnitude of executive option backdating in financial and nonfinancial firms.Design/methodology/approachUsing a sample of CEO stock option grants from 1995 to 2006, obtained from ExecuComp, the authors employ an event study around the grant dates of executive options. The authors compare the abnormal price movements between financial and nonfinancial firms.FindingsThe abnormal negative stock returns were found before the award dates for both groups of firms. The after-event abnormal returns of both groups of firms, however, show different trends. For nonfinancial firms, there is an immediate turnaround of the abnormal return movement right after the grants; that is, the price increases, indicating the occurrence of significant backdating events. For financial firms, however, there is no significant price rebound after the grant date. In fact, the price continued to decline throughout the after-event period.Research limitations/implicationsThe result shows that nonfinancial firms demonstrate significantly more option backdating behavior than financial firms.Practical implicationsThe findings suggest that previous findings on prevalent backdating among all public listed firms are only partially correct. This paper shows that backdating behavior found in previous studies is indeed driven by nonfinancial firms. This unexpected finding contradicts the initial prediction of authors that option backdating may be more likely among financial firms.Originality/valueBased on previous research, the authors recognize that generally the official grant dates of firms must have been set retroactively, as shown by Lie (2005). The findings, however, show that financial firms demonstrate only partial backdating behavior. This study opens a path for future research to further discover why financial firms exhibit less backdating behavior compared with nonfinancial firms, and if option backdating is not an issue for financial firms, why the share prices of these firms decline significantly prior to the grant date.

Call options with concave payoffs: An application to executive stock options

We observe that the incentive effects of traditional stock options can be improved by making the option's payoff concave in the region of a high stock price at maturity. To reflect the concave property, we propose two types of executive stock options: a generalized power option and an ordinary bull spread. Under the [Hall and Murphy (): American Economic Review 209‐214, Hall and Murphy () Journal of Accounting and Economics 33: 3‐42] framework, we show that the generalized power option with high concavity and the ordinary bull spread generate greater incentive effects than those of traditional options or the [Bernard, Boyle, and Chen (): The Journal of Derivatives 23: 9‐20] power executive options.