Evidence that stock options work for CEOs - but not for incentive reasons

Abstract

We document the first evidence of a structure of timing returns, award discounts/premia and CEO dilution costs relative to shareholders set at award and before the CEO invests marginal effort. All three factors affect CEOs’ effective exercise price and hence incentive to expend marginal effort. Exercised options, which exhibit the highest CEO and shareholder returns, are characterized by CEO acceptance of high dilution cost and high sensitivity to award premiums. CEO and shareholder returns for lapsed options and annual/biannual awards show high dependency on the dilution cost factor. Irregular awards are characterized by active pre-effort positioning by shareholders to reduce CEO opportunism.