Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/123380
Authors: 
Drobetz, Wolfgang
Pensa, Pascal
Schmid, Markus M.
Year of Publication: 
2007
Series/Report no.: 
WWZ Working Paper 17/07
Abstract: 
It is often argued that Black-Scholes (1973) values overstate the subjective value of stock options granted to risk-averse and under-diversified executives. We construct a “representative” Swiss executive and extend the certainty- equivalence approach presented by Hall and Murphy (2002) to assess the value-cost wedge of executive stock options. Even with low coefficients of relative risk aversion, the discount can be above 50% compared to the Black-Scholes values. Regression analysis reveals that the equilibrium level of executive compensation is explained by economic determinant variables such as firm size and growth opportunities, whereas the managers' pay-forperformance sensitivity remains largely unexplained. Firms with larger boards of directors pay higher wages, indicating potentially unresolved agency conflicts. We reject the hypothesis that cross-sectional differences in the amount of executive pay vanish when risk-adjusted values are used as the dependent variable.
Subjects: 
Managerial compensation
incentives
executive stock options
option valuation
risk aversion
JEL: 
J33
G13
G32
Document Type: 
Working Paper

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