The third—megagrants—consists of onetime lump sum distributions. The three types of plans provide very different incentives and entail very different risks. With fixed value plans, executives receive options of a predetermined value every year over the life of the plan.

Fixed value plans are popular today. Fixed value plans are therefore ideal for the many companies that set executive pay according to studies performed by compensation consultants that document how much comparable executives are paid and in what form. But fixed value plans have a big drawback. Because they set the value of future grants in advance, they weaken the link between pay and performance.

Executives end up receiving fewer options in years of strong performance and high stock values and more options in years of weak performance and low stock values.

The stock price has doubled; the number of options John receives has been cut in half. He ends up, in other words, being given a much larger piece of the company that he appears to be leading toward ruin. For that reason, fixed value plans provide the weakest incentives of the three types of programs. I call them low-octane plans. Whereas fixed value plans stipulate an annual value for the options granted, fixed number plans stipulate the number of options the executive will receive over the plan period.

Under a fixed number plan, John would receive 28, at-the-money options in each of the three years, regardless of what happened to the stock price.

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Here, obviously, there is a much stronger link between pay and performance. Since the value of at-the-money options changes with the stock price, an increase in the stock price today increases the value of future option grants. Likewise, a decrease in stock price reduces the value of future option grants. Since fixed number plans do not insulate future pay from stock price changes, they create more powerful incentives than fixed value plans. I call them medium-octane plans, and, in most circumstances, I recommend them over their fixed value counterparts.

Now for the high-octane model: the lump-sum megagrant. While not as common as the multiyear plans, megagrants are widely used among private companies and post-IPO high-tech companies, particularly in Silicon Valley. Megagrants are the most highly leveraged type of grant because they not only fix the number of options in advance, they also fix the exercise price. Shifts in stock price have a dramatic effect on this large holding.

Every few years since , Eisner has received a megagrant of several million shares. Since the idea behind options is to gain leverage and since megagrants offer the most leverage, you might conclude that all companies should abandon multi-year plans and just give high-octane megagrants.

When viewed in those terms, megagrants have a big problem. Look at what happened to John in our third scenario. After two years, his megagrant was so far under water that he had little hope of making much money on it, and it thus provided little incentive for boosting the stock value.

And he was not receiving any new at-the-money options to make up for the worthless ones—as he would have if he were in a multiyear plan. It would provide him with a strong motivation to quit, join a new company, and get some new at-the-money options. Ironically, the companies that most often use megagrants—high-tech start-ups—are precisely those most likely to endure such a worst-case scenario. Their stock prices are highly volatile, so extreme shifts in the value of their options are commonplace. And since their people are in high demand, they are very likely to head for greener pastures when their megagrants go bust.

Indeed, Silicon Valley is full of megagrant companies that have experienced human resources crises in response to stock price declines. Such companies must choose between two bad alternatives: they can reprice their options, which undermines the integrity of all future option plans and upsets shareholders, or they can refrain from repricing and watch their demoralized employees head out the door. Silicon Valley companies could avoid many such situations by using multiyear plans. The answer lies in their heritage.

Before going public, start-ups find the use of megagrants highly attractive. Accounting and tax rules allow them to issue options at significantly discounted exercise prices. The risk profile of these pre-IPO grants is actually closer to that of shares of stock than to the risk profile of what we commonly think of as options. When they go public, the companies continue to use megagrants out of habit and without much consideration of the alternatives.

But now they issue at-the-money options. What had been an effective way to reward key people suddenly has the potential to demotivate them or even spur them to quit. Some high-tech executives claim that they have no choice—they need to offer megagrants to attract good people. Yet in most cases, a fixed number grant of comparable value would provide an equal enticement with far less risk. With a fixed number grant, after all, you still guarantee the recipient a large number of options; you simply set the exercise prices for portions of the grant at different intervals.

By staggering the exercise prices in this way, the value of the package becomes more resilient to drops in the stock price.

Switching to multiyear plans or staggering the exercise prices of megagrants are good ways to reduce the potential for a value implosion. Small, highly volatile Silicon Valley companies are not the only ones that are led astray by old habits. Large, stable, well-established companies also routinely choose the wrong type of plan. But they tend to default to multiyear plans, particularly fixed value plans, even though they would often be better served by megagrants. Think about your average big, bureaucratic company.

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The greatest threat to its well-being is not the loss of a few top executives indeed, that might be the best thing that could happen to it. The greatest threat is complacency. To thrive, it needs to constantly shake up its organization and get its managers to think creatively about new opportunities to generate value. The high-octane incentives of megagrants are ideally suited to such situations, yet those companies hardly ever consider them. Why not? The bad choices made by both incumbents and upstarts reveal how dangerous it is for executives and board members to ignore the details of the type of option plan they use.

While options in general have done a great deal to get executives to think and act like owners, not all option plans are created equal.

Only by building a clear understanding of how options work—how they provide different incentives under different circumstances, how their form affects their function, how various factors influence their value—will a company be able to ensure that its option program is actually accomplishing its goals. If distributed in the wrong way, options are no better than traditional forms of executive pay. Article Google Scholar. Black, F. Brickley, J. Bhagat and R. Cho, M. Core, J. Dechow, P. Defusco, R. Johnson and T. Demsetz, H.

Downs, D. Hall, J. Hanlon, M. Haugen, A. Himmelberg, C. Hubbard, and D. Hite, G. Hermalin, B. Holderness, C. Kroszner and D. Ittner, C. Lambert and D. Jensen, M. Lewellen, W. Loderer and A. Loderer and K. Ljung, M. Mandelker, G. McConnell, J. Morck, R. Shleifer and R. Murphy, K. Palia, D. Rajgopal, S. Saunders, A. Strock, E. Schrand, C. Rooted in these ideas, we empirically test the hypothesis that the last-minute unscheduled options granted to target CEOs are substitutes of golden parachutes. Whereas when dividends are zero we have e.

Expressed differently, in the case with dividends it is possible to have many time- homogeneous diffusion models for which put prices are identical. A Quasi analytical Interpolation Method for Pricing American Options under General Multi dimensional Diffusion Processes This paper belongs to the second group that looks at the issue of computing American option prices. By now, more than a dozen well-established pricing methods exist, as well as many others that have not been widely adopted.

For a relatively recent but brief survey, see Barone-Adesi These methods differ in dimensions such as efficiency, accuracy, generality, robustness, portability to other derivatives or other processes, ease of implementation, etc. In addition to offering a broader menu of pricing methods for practitioners to choose from, the development of new methods often offers considerable additional insights on various aspects of American options. Because of the huge variety of proposed methods, a clear and unambiguous classification of all the different methods is difficult.

Nonetheless, they can be roughly divided into several somewhat distinctive groups. The first group is the numerical methods based on solving the valuation partial differential equation. Those include the binomial tree method Cox, Ross and Rubinstein , Rendleman and Barrter , Curran , trinomial tree methods and other variations Parkinson , Breen , Kamrad and Ritchken ,. Weakening Effect of Executive Overconfidence on Equity Incentive—The Empirical Evidence from Chinese Listed Companies According to the optimal contract theory, the shareholders or the board of di- rectors who are faithful representatives of their interests can solve the agency problem by designing an effective executive compensation contract.

The equity compensation is highly praised and widely application because it can link the interests of shareholders and executives closely Jensen and Meckling, [2]. Scholars also confirmed the positive role of equity compensation contracts in solving risk agency problems through multiple variables such as the value, quan- tity or proportion of equity compensation such as stock options and restricted stocks. For example, equity compensation can encourage executives to expand investment scale. However, these studies have not profoundly revealed the mechanism of action of equity compensation.

Jensen [13] take the lead in using. Evidence from China Since Hong Kong appears to have more stringent governance rules and a better investor protection than mainland China, executive compensation of HK companies is often more sensitive to company performance than that of mainland companies. The question is whether cross-listed companies have become assimilated to HK local firms in linking executive pay to performance.

We cannot disentangle these two effects. Our focus is to test whether the overall effect of cross-listing is positive.

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• Do executive stock option grants have value implications for firm performance? | SpringerLink!
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One distinguishing feature of our study is that we set two benchmarks for Chinese companies cross-listed in Hong Kong: one is based on executive incentives of mainland A-share companies; the other is.