Incentive Efficiency of Stock versus Options

This paper examines the relative incentive costs of using stockversus options in management incentive contracts that use market priceas the performance measure. We establish that if the manager'seffort has little or no effect on a firm's operating risk, thenthe cost of incentive risk is less using stock rather than options.However, this result is reversed if the manager's effort has asignificant impact on the firm's operating risk.