Executive Stock Options and the Mediation of Stockholder-Bondholder Conflicts

University of British Columbia FIN98-7

30 Pages Posted: 18 Aug 1998

See all articles by Gerald T. Garvey

Gerald T. Garvey

Blackrock

Amin Mawani

York University - Department of Accounting

Date Written: July 1998

Abstract

Financial leverage does not distort investment decisions if executives are paid to maximize total firm value rather than equity value. Existing models of this idea imply that stock-based incentives should be negatively related to firm leverage, a prediction that has little empirical support. We show that the risk distortions induced by financial leverage can be overcome without diluting effort incentives by adjusting the exercise price of executive stock options. We also show that the necessary adjustments are similar to the common practice of granting options at-the-money. We then empirically examine the risk incentives of executive stock option plans in a large sample of Canadian firms. The evidence consistently supports the hypothesis that executive stock options mitigate the risk-taking incentives of shareholders in levered firms.

JEL Classification: G32, G31

Suggested Citation

Garvey, Gerald T. and Mawani, Amin, Executive Stock Options and the Mediation of Stockholder-Bondholder Conflicts (July 1998). University of British Columbia FIN98-7, Available at SSRN: https://ssrn.com/abstract=111068 or http://dx.doi.org/10.2139/ssrn.111068

Gerald T. Garvey (Contact Author)

Blackrock ( email )

Level 37, Chifley Tower
2 Chfiley Square
Sydney, NSW 2000
Australia
+61 2 9272 2388 (Phone)

Amin Mawani

York University - Department of Accounting ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

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