Does backdating explain the stock price pattern around executive stock option grants?

We examine the valuation of executive stock option award where there is a rebate at exercise. The rebate depends on the performance of the stock of the corporation over time the period concerned; in particular we consider the situation where the executive can purchase the stock at exercise time at discount proportional to the minimum value of the stock price over the exercise period. Valuation formulae are provided both when assessment is done in discrete time as well as in continuous time. Some numerical illustrations are also presented

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The Original Management Incentive Schemes

The Journal of Economic Perspectives ◽

10.1257/089533005775196688 ◽

2005 ◽

Vol 19 (4) ◽

pp. 135-144 ◽

Cited By ~ 8

Author(s):

Richard T Holden

Keyword(s):

Stock Prices ◽

Stock Price ◽

Stock Option ◽

Stock Index ◽

General Motors ◽

Executive Stock Option ◽

Incentive Schemes ◽

Corporate Executives ◽

Short Run ◽

Excessive Risk Taking

During the 1990s, the structure of pay for top corporate executives shifted markedly as the use of stock options greatly expanded. By the early 2000s, as the dot-com boom ended and the Nasdaq stock index melted down, these modern executive incentive schemes were being sharply questioned on many grounds—for encouraging excessive risk-taking and a short-run orientation, for being an overly costly and inefficient method of providing incentives, and even for tempting managers of firms like Enron, WorldCom and Tyco to commit fraud in order to ensure a high stock price at the time of exercise. This article examines executive incentive schemes developed by Du Pont and General Motors in the 1920s —the original incentive schemes linking executive compensation to stock prices. The author argues that these plans were well-designed to pre-empt and address many of the criticisms of modern-day executive stock option plans.

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Option repricing and executive retention – revisited

Review of Accounting and Finance ◽

10.1108/raf-01-2016-0011 ◽

2016 ◽

Vol 15 (4) ◽

pp. 499-517

Author(s):

Sandra Renfro Callaghan ◽

Chandra Subramaniam ◽

Stuart Youngblood

Keyword(s):

Stock Price ◽

Stock Options ◽

Control Sample ◽

Stock Option ◽

Executive Turnover ◽

Content Type ◽

Executive Stock Option ◽

Managerial Talent ◽

Option Repricing ◽

Stock Option Repricing

Purpose This paper aims to directly test the assertion by proponents of executive stock option repricing that repricing leads to increased management retention. Previous studies find either no effect or decreased retention following stock price repricing. This paper uses a more precise research design to re-examine the relationship between stock option retention and management retention. Design/methodology/approach The authors use an empirical methodology and construct a sample of 158 firms and 201 repricing events, and a control sample of 201 non-repricing firms. They then examine executive turnover in the four years following the stock option repricing event. Findings It was found that, consistent with agency theory, stock option repricing actually results in greater executive retention. Specifically, CEO retention is significantly greater for repricing firms relative to non-repricing firms for up to three years following the repricing date, and non-CEO executive retention is significantly greater for two years. Research limitations/implications Firms continue to restructure management through stock option repricing. However, recent option repricing has been undertaken during a period when the economy is in decline, making it is difficult to disentangle effects of option repricing on management retention. Hence, this paper uses repricing data from an earlier period, from 1992-1997, when the economy was good. Originality/value Many firms argue that when stock options are out-of-the-money and managerial talent is in demand, repricing executive stock options is necessary to retain managers. Previous studies find contradictory or no support for this view. Using a much more precise methodology, this paper shows that firms do retain managers when they reprice their options compared to when they do not.

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THE VALUE OF BEING LUCKY: OPTION BACKDATING AND NONDIVERSIFIABLE RISK

International Journal of Theoretical and Applied Finance ◽

10.1142/s0219024921500230 ◽

2021 ◽

pp. 2150023

Author(s):

VICKY HENDERSON ◽

JIA SUN ◽

A. ELIZABETH WHALLEY

Keyword(s):

Risk Aversion ◽

Stock Prices ◽

Stock Price ◽

Stock Option ◽

Risk Averse ◽

Executive Stock Option ◽

Early Exercise ◽

Lookback Option ◽

Utility Indifference ◽

Option Compensation

The practice of executives influencing their option compensation by setting a grant date retrospectively is known as backdating. Since executive stock options are usually granted at-the-money, selecting an advantageous grant date to coincide with a low stock price will be valuable to an executive. Empirical evidence shows that backdating of executive stock option grants was prevalent, particularly at firms with highly volatile stock prices. Executives who have the opportunity to backdate should take this into account in their valuation. We quantify the value to a risk averse executive of a lucky option grant with strike chosen to coincide with the lowest stock price of the month. We show the ex ante gain to risk averse executives from the ability to backdate increases with both risk aversion and with volatility, and is significant in magnitude. Our model involves valuing the embedded partial American lookback option in a utility indifference setting with key features of risk aversion, inability to diversify and early exercise.

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OPTIMAL EXERCISE OF AN EXECUTIVE STOCK OPTION BY AN INSIDER

International Journal of Theoretical and Applied Finance ◽

10.1142/s0219024911006279 ◽

2011 ◽

Vol 14 (01) ◽

pp. 83-106 ◽

Cited By ~ 3

Author(s):

MICHAEL MONOYIOS ◽

ANDREW NG

Keyword(s):

Stock Price ◽

Stock Option ◽

Stopping Times ◽

Inside Information ◽

Executive Stock Option ◽

Early Exercise ◽

Noisy Information ◽

Exercise Boundary ◽

Inhomogeneous Diffusion ◽

The Value Function

We consider an optimal stopping problem arising in connection with the exercise of an executive stock option by an agent with inside information. The agent is assumed to have noisy information on the terminal value of the stock, does not trade the stock or outside securities, and maximises the expected discounted payoff over all stopping times with regard to an enlarged filtration which includes the inside information. This leads to a stopping problem governed by a time-inhomogeneous diffusion and a call-type reward. We establish conditions under which the option value exhibits time decay, and derive the smooth fit condition for the solution to the free boundary problem governing the maximum expected reward, and derive the early exercise decomposition of the value function. The resulting integral equation for the unknown exercise boundary is solved numerically and this shows that the insider may exercise the option before maturity, in situations when an agent without the privileged information may not. Hence we show that early exercise may arise due to the agent having inside information on the future stock price.

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