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Journal of Corporate Finance Vol. 29 2014

Options, option repricing in managerial compensation: Their effects on corporate investment risk

Nengjiu Ju1; Hayne E. Leland2; Lemma W. Senbet3,4

1 Shanghai Advanced Institute of Finance, Shanghai Jiatong University, China · 2 University of California, Berkeley · 3 African Economic Research Consortium · 4 University of Maryland, College Park

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.

DOI
10.1016/j.jcorpfin.2013.11.003
Volume
29
Pages
628-643
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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