Are Executive Stock Options Associated with Future Earnings?

Are Stock Options Grants to CEOs of Stagnant Firms Fair and Justified?

“…The sum of the coefficients of present and past stock options, P 5 k¼0 a 2;k , is 3.84 and is significantly greater than one (p < 0.01). This result is consistent with Hanlon et al (2003). It indicates that the undiscounted future operating income associated with a dollar of Black-Scholes value of CEO stock options is $3.84.…”

“…We extend the research of Hanlon et al (2003), who document that a dollar of past executive stock options grants results in more than a dollar increase in future operating earnings. Our analysis indicates that this relation does not hold for stagnant firms, i.e., a dollar of past executive stock options grants does not result in more than a dollar of future operating earnings.…”

“…Prior research provides evidence suggesting that managers abuse options grants for their own benefit (Aboody and Kasznik, 2000;Yermack, 1997). This is generally referred to as the rent extraction hypothesis (Hanlon et al, 2003) or managerial power approach (Bebchuk et al, 2002).…”

“…We follow the approach of Hanlon et al (2003) to examine the association between current and past options grants and current earnings. This approach views the value of stock options grants as investments by the firm that will generate future earnings.…”

“…(p. 339). More recently, Hanlon et al (2003) document that for each dollar spent on stock options grants to their top five executives, firms generate close to four dollars in future operating income.…”