The Minimum Assumed Incentive Effect of Executive Share Options

Abstract

In granting executive share options (ESOs), companies hand over financial assets to the executive at an opportunity cost that generally outweighs the value placed on those assets by the executive on the receiving end. This outcome can be explained by risk aversion on the part of the executives. For such transactions to make commercial sense, the difference in valuation must be at least made up by the impact of the incentive effects induced by compensating executives in this particular manner. This paper extends such a line of analysis to examine the executive's reward-risk trade-off, in addition to the certainty-equivalent pay-performance sensitivity and uses a UK data set to provide some estimates of the size of these effects