Managerial Stock Options Research Articles

Leverage, Volatility and Executive Stock Options

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.

Corporate payout policy and managerial stock incentives

We examine how corporate payout policy is affected by managerial stock incentives using data on more than 1,100 nonfinancial firms during 1993–97. We find that management stock ownership is associated with higher payouts by firms with potentially the greatest agency problems – those with low management stock ownership and few investment opportunities or high free cash flow. We also find that management stock options are related to the composition of payouts. We find a strong negative relationship between dividends and management stock options, as predicted by Lambert et al (1989), and a positive relationship between repurchases and management stock options. Our results suggest that the growth in stock options may help to explain the rise in repurchases at the expense of dividends.

Corporate Payout Policy and Managerial Stock Incentives

We examine how corporate payout policy is affected by managerial stock incentives using data on more than 1100 nonfinancial firms during 1993-97. We find that management share ownership encourages higher payouts by firms with potentially the greatest agency problems--those with low market-to-book ratios and low management stock ownership. We also find that management stock options change the composition of payouts. We find a strong negative relationship between dividends and management stock options, as predicted by Lambert, Lannen, and Larcker (1989), and a positive relatinship between repurchases and management stock options. Our results suggest that the growth in stock options may help to explain the rise in repurchases at the expense of dividends.

Explaining Performance Changes in Newly Privatized Firms

Much debate has been generated about whether privatization tends to enhance firm financial performance. The research presented here seeks to identify the strategic choices that differentiated firms with superior post‐privatization performance from those with inferior post‐privatization performance.Using agency theory as a theoretical foundation, it is hypothesized that superior post‐privatization firm performance will be associated with (1) the government not retaining a significant stock holding, (2) changes in leadership, (3) management stock options being initiated, (4) employee head count being reduced, and (5) the company being restructured financially. The sample draws from 41 privatized firms from six industry classifications and 15 countries. To accommodate comparisons of small subsamples, non‐parametric statistical methods are used. Controlling for size, industry and country (economic/regulatory effects), the hypotheses are generally supported except for the one relating to headcount.

Good News and Bad News about Share Repurchases

We estimate the cross-sectional relationship between open market repurchases and accounting data for a large sample of dividend- paying and non-dividend paying firms over a twelve year period (1984-95). Consistent with the hypothesis that firms use open market repurchases to reduce the agency costs of free cash flow, we find that repurchases are positively related to proxies for free cash flow and negatively related to proxies for marginal financing costs. We also examine the extent to which management stock options influence the choice between open market repurchases and dividend payments. Because the value of management stock options--like any call option--is negatively related to expected future dividend payments, management can increase the value of its stock options by substituting share repurchases for dividend growth. We find evidence that such substitution occurs: for dividend-paying firms, share repurchases are positively related and dividend increases are negatively related to a proxy for management stock options, whereas for non-dividend-paying firms, the relationship between repurchases and options is weak and statistically insignificant.

Good News and Bad News about Share Repurchases

We estimate the cross-sectional relationship between open market repurchases and accounting data for a large sample of dividend- paying and non-dividend paying firms over a twelve year period (1984-95). Consistent with the hypothesis that firms use open market repurchases to reduce the agency costs of free cash flow, we find that repurchases are positively related to proxies for free cash flow and negatively related to proxies for marginal financing costs. We also examine the extent to which management stock options influence the choice between open market repurchases and dividend payments. Because the value of management stock options--like any call option--is negatively related to expected future dividend payments, management can increase the value of its stock options by substituting share repurchases for dividend growth. We find evidence that such substitution occurs: for dividend-paying firms, share repurchases are positively related and dividend increases are negatively related to a proxy for management stock options, whereas for non-dividend-paying firms, the relationship between repurchases and options is weak and statistically insignificant.

Repeated Auctions of Incentive Contracts, Investment, and Bidding Parity with an Application to Takeovers

This article considers a two-period model of natural monopoly and second-sourcing. The incumbent supplier invests in the first period. After observing the incumbent's first-period performance, the buyer may break out in the second period. The investment may or may not be transferable to the second source, and it may be monetary or take the form of human capital. We determine whether the incumbent should be favored at the reprocurement stage, and how the slope of his incentive scheme should evolve over time. We find that the gains from second-sourcing are not so large as one might hope. Finally, we reinterpret the second source as a raider and the breakout as a takeover. We discuss the desirability of defensive tactics and obtain a rich set of testable implications concerning the size of managerial stock options, the extent of defensive tactics, the firm's performance, and the probability of a takeover.

On the Resolution of Agency Problems by Complex Financial Instruments: A Comment

a) convertible debt or b) a package of external equity and managerial stock options, (ii) the agency problems resulting from the shareholders' incentive to bear unwanted risk (also referred to as risk shifting) can be resolved by issuing callable debt, and (iii) welfare loss due to informational asymmetry between insiders and the market can be reduced by issuing callable debt. In this paper, we derive results that contradict these conclusions of BHS and HS. We prove that convertible debt cannot costlessly resolve the agency problem due to excessive perquisite consumption. Farmer and Winter [4] have recently shown that managerial stock options cannot resolve the problem. We also show that convertible debt, in general, does not even mitigate this problem. Next, we show that the argument that callable debt resolves agency problems due to risk shifting and informational asymmetry is incomplete. The paper is organized as follows. Section I deals with the perquisite consumption problem; Section II deals with both risk shifting and informational asymmetry problems since the basis of their resolution in the BHS argument is the same.

Resolving the Agency Problems of External Capital through Options

ABSTRACTThis paper investigates the role of stock options in resolving the agency problems of external capital as originally identified by Jensen and Meckling (1976). These problems are precipitated by managerial incentives a) to consume excessive non‐pecuniary benefits or perquisites beyond the optimal level for sole ownership and b) to engage in risk shifting in productive decisions so as to transfer wealth from external capital contributors. These incentive problems can be resolved through a strategy that judiciously combines call and put options retained by the owner‐manager and external financiers, respectively. The resolution of the agency problems through this mechanism provides an economic rationale for the existence of managerial stock options and convertible debt.

Management’s Fourth Dimension

THIS PAPER contends that managements of publicly held corporations are now evolving a new "fourth dimension". In its traditional role of supplying better products at lower prices, management has practiced, with increasing efficiency, in the dimensions of: 1 ) production, 2) finance and 3) marketing. Now management is responding to a demand for a new result-to maximize the value of the corporation's common stock. Managements are concerned with this demand in varying relative degrees. A new management is evolving which is primarily concerned with this. We shall explore how this demand originates and how management responds. In a free economy, producers are constantly responding to the demands of consumers. This is no less true in the field of investments. As tastes of the investor (who is the consumer of investment value) have changed, over the years, the corporate manager (the producer of investment value) has responded. Investors influence management philosophy by bidding up the market price of stocks of companies whose managements they approve and depressing (through sales) the market price of stocks of companies whose managements they disapprove. Significantly, the increasing use of management stock option plans has made managements personally more sensitive to the long-term price action of their stocks.