Jackwerth, Jens Carsten and Hodder, James E. (2008): Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management.
Download (322Kb) | Preview
We model a firm’s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also dynamically controls allocation of his outside wealth. We explore interactions between those controls as he partially hedges his exposure to firm risk. Conditioning on his optimal behavior, control of firm risk increases the expected time to exercise for his employee stock options. It also reduces the percentage gap between his certainty equivalent and the firm’s fair value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile.
|Item Type:||MPRA Paper|
|Original Title:||Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management|
|English Title:||Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management|
|Keywords:||Risk; Wealth Management; Derivative|
|Subjects:||G - Financial Economics > G3 - Corporate Finance and Governance
G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
|Depositing User:||Jens Jackwerth|
|Date Deposited:||19. Nov 2008 06:48|
|Last Modified:||13. Feb 2013 04:56|
Bakshi, Gurdip, Nikunj Kapadia, and Dilip Madan (2003). “Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies 16, No. 1, 101-143.
Basak, S., A. Pavlova, and A. Shapiro (2007). “Optimal Asset Allocation and Risk Shifting in Money Management.” Review of Financial Studies 20, No. 5, 1583-1621.
Bettis, J. Carr, Bizjak, John M., and Michael L. Lemmon (2005). “Exercise behavior, valuation, and the incentive effects of employee stock options.” Journal of Financial Economics 76, No. 2, 445-470.
Cai, Jie and Anand M. Vijh (2005). “Executive Stock and Option Valuation in a Two-State- Variable Framework.” Journal of Derivatives 12, No. 3, 9-27. Carpenter, Jennifer N. (1998). “The Exercise and Valuation of Executive Stock Options.” Journal of Financial Economics 48, No. 2, 127-158.
Carpenter, Jennifer. N. (2000). “Does Option Compensation Increase Managerial Risk Appetite?” Journal of Finance 55, No. 5, 2311-2331.
Core, John E., Wayne Guay, and David F. Larker (2003). “Executive Equity compensation and Incentives: A Survey.” Economic Policy Review 9, No. 1, 27-50.
Cuoco, Dominico and Ron Kaniel (2006). “Equilibrium Prices in the Presence of Delegated Portfolio Management.” Working Paper, University of Pennsylvania.
Dennis, Patrick, and Stewart Mayhew (2000). “Implied Volatility Smiles: Evidence From Options on Individual Equities.” Working Paper, University of Virginia.
Detemple, Jerome and Suresh Sundaresan (1999). “Nontraded Asset Valuation with Portfolio Constraints: A Binomial Approach.” Review of Financial Studies 12, No. 4, 835-872. Garman, Mark (1989). “Semper Tempus Fugit.” RISK 2, No. 5, 34-35.
Hall, Brian J., and Kevin J. Murphy (2002). “Stock Options for Undiversified Executives.” Journal of Accounting and Economics 33, No. 1, 3-42.
Henderson, Vicky (2005). “The impact of the market portfolio on the valuation, incentives and optimality of executive stock options.” Quantitative Finance 5, No. 1, 35-47.
Hodder, James E and Jens C. Jackwerth (2007). “Incentive Contracts and Hedge Fund Management.” Journal of Financial and Quantitative Analysis 42, No. 4, 811-826.
Huddart, Steven (1994). “Employee Stock Options.” Journal of Accounting and Economics 18, No. 2, 207-231.
Huddart, Steven and Mark Lang (1996). “Employee stock option exercises: An empirical analysis.” Journal of Accounting and Economics 21, No. 1, 5-43. Ingersoll, Jonathan E. (2006). “The Subjective and Objective Evaluation of Incentive Stock Options.” Journal of Business 79, No. 2, 453-487.
Ju, Nengjiu, Hayne Leland, and Lemma W. Senbet (2003). “Options, Option Repricing and Severance Packages in Managerial Compensation: Their Effects on Corporate Investment Risk.” Working paper, University of Maryland.
Judd, Kenneth L. (1998). Numerical Methods in Economics, MIT Press, Cambridge, MA.
Kahl, Matthias, Jun Liu, and Francis A. Longstaff (2003). “Paper millionaires: How valuable is stock to a stockholder who is restricted from selling it?” Journal of Financial Economics 67, No. 3, 385-410.
Kulatilaka, Nalin, and Alan J. Marcus (1994). ”Valuing Employee Stock Options.” Financial Analyst Journal 50, No. 6, 46-56.
Kushner, Harold J., and Paul G. Dupuis (2001). Numerical Methods for Stochastic Control Problems in Continuous Time, 2nd ed., Springer Verlag, New York, Berlin, Heidelberg. Lambert, Richard A., David F. Larcker, and Robert E.
Verrecchia (1991). “Portfolio Considerations in Valuing Executive Compensation.” Journal of Accounting Research 29, No. 1, 129-149.
Merton, Robert (1969), “Lifetime Portfolio Selection under Uncertainty: The Continuous Time Case.” Review of Economics and Statistics 51, No. 3, 247-257