Employee Stock Option Compensation: A behavioral finance approach (Management, Organisation und ökonomische Analyse, 2)

Stock options have become a common part of the compensation of executives in many companies. Their use has created a significant amount of controversy among academics as well as among the general public. Florian Cornelis Wolff addresses an aspect often overlooked in debate but crucial for assessment: How do executives themselves see their stock options? How do their personal expectations and risk preferences affect the value they assign to them? To answer these questions classical option valuation approaches need to be combined with recent findings from the field of behavioural finance. The result is quite surprising: It is because people behave irrationally that stock options may be worth their money. Over the last years stock options have become an integral part of the compensation of senior managers in Germany: Originating in the USA in the 1950s, this form of compensation gained increasing popularity among German corporations during the 1990s, so that by today far over 100 German listed companies grant stock option plans to their employees. Based on recent research the average German CEO ('Vor­ standsvorsitzender') receives approximately 10% of his salary in form of stock op­ tions. The ongoing globalisations of business practises as well as the boom of the Neuer Markt have been key drivers of this development. Initially, from an economic perspective the increasing importance of stock option plans in the compensation of senior managers has to be welcomed: Assuming that senior managers through their actions have the ability to influence the stock price of their companies, stock options represent a performance based type of pay that im­ proves the incentives to senior managers to create additional shareholder value. However, this perspective often neglects the potential costs created by such an in­ centive instrument. Several research studies suggest that companies in some cases generate additional costs through the granting of stock options that can exceed the benefits created by their incentive effect. Front Matter....Pages I-XV Introduction to the topic....Pages 1-14 Theoretical & empirical assessment....Pages 15-52 Review of risk-neutral valuation models....Pages 53-77 Utility-based stock-option valuation....Pages 79-144 A new model to value executive stock option....Pages 145-193 Experimental test of subjective valuations....Pages 195-215 Conclusion and outlook....Pages 217-222 Back Matter....Pages 223-255 Florian Wolff analyses how executives perceive their stock options and how their personal expectations and risk preferences affect the value they assign to them. He shows that stock options may be worth their money because people behave irrationally.