Options,option repricing in managerial compensation: Their effects on corporate investment risk |
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| Affiliation: | 1. Shanghai Advanced Institute of Finance, Shanghai Jiatong University, China;2. The Haas School of Business, University of California, Berkeley, CA 94720, United States;3. The Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, United States;4. African Economic Research Consortium (www.aercafrica.org), Nairobi, Kenya;1. Sam M. Walton College of Business, University of Arkansas, Business Building 302, Fayetteville, AR 72701, United States;2. Daniels College of Business, University of Denver, 2101 S. University Blvd., Denver, CO 80208, United States |
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| Abstract: | While stock options are commonly used in managerial compensation to provide desirable incentives, they can create adverse incentives to distort the choice of investment risk. Relative to the risk level that maximizes firm value, call options in a compensation contract can induce too much or too little corporate risk-taking, depending on managerial risk aversion and the underlying investment technology. We show that inclusion of lookback call options in compensation packages has desirable countervailing effects on managerial choice of corporate risk policies and can induce risk policies that increase shareholder wealth. We argue that lookback call options are analogous to the observed practice of option repricing. |
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