Stock Options, Restricted Stock, and Incentives

48 Pages Posted: 3 May 2004

See all articles by Richard A. Lambert

Richard A. Lambert

University of Pennsylvania - Accounting Department

David F. Larcker

Stanford University - Graduate School of Business; European Corporate Governance Institute (ECGI); Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance

Date Written: April 2004

Abstract

Prior work has suggested that options represent an inefficient form of compensation because the value placed on an option by a risk-averse employee is much less than the cost of the option from the perspective of the firm. However, much of this work ignores or fails to properly incorporate the incentive effect of option-based contracts into their analysis. We use agency theory to model the optimal mix of options and stock in the compensation contract. In contrast to prior work, we show that restricted stock is generally not the optimal contract form. We present comparative static results to show how the mix between options and stock and the optimal exercise price of the options varies as a function of the exogenous parameters.

Keywords: Stock options, agency models, incentives

JEL Classification: J33, M52, M41

Suggested Citation

Lambert, Richard and Larcker, David F., Stock Options, Restricted Stock, and Incentives (April 2004). Available at SSRN: https://ssrn.com/abstract=527822 or http://dx.doi.org/10.2139/ssrn.527822

Richard Lambert (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-7782 (Phone)
215-573-5463 (Fax)

David F. Larcker

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance ( email )

Crown Quadrangle 559 Nathan Ab
Stanford, CA 94305-8610
United States

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