On Target: An Examination of CEO Stock Option Performance Hurdles

Orszag, J. Michael; Choudhary, Ali

doi:10.2139/ssrn.892769

Cited by 2 publications

(1 citation statement)

References 11 publications

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“…Executive stock options linked to earnings performance are commonplace. Orszag and Choudhary (2005) document that in 2003, amongst firms that made up the FTSE100, 79 percent of them used earnings per share growth as a performance hurdle while the remainder used other benchmarks such as total return to shareholders relative to a market index. Many prominent companies in Australia and New Zealand have implemented a performance hurdle in their executive stock options with two distinguishing features:The options have a strike price that drifts upward at a rate set with reference to a cost of capital estimate.Dividend protection that adjusts the strike price downward by the amount of any dividends paid1.…”

Section: Introductionmentioning

confidence: 99%

The cost of granting executive stock options with strike prices adjusted by the cost of capital

Cheung

Corrado

2007

Pacific Accounting Review

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Purpose-The purpose of this paper is to estimate the cost of granting executive stocks with strike prices adjusted by the cost of capital. Design/methodology/approach-In the paper a Monte Carlo simulation approach developed in Longstaff and Schwartz is used in conjunction with the subjective valuation model developed in Ingersoll to value these executive stock options that are subject to performance hurdles. Findings-The paper finds that standard European Black-Scholes-Merton option values overstate the true cost to the firm of granting these executive stock options. The option values also decrease with a higher dividend yield, a higher performance hurdle, a longer vesting period, and a shorter maturity. Research limitations/implications-While the study in the paper is limited to the valuation of executive options, the methodology can be used to study incentive effects of executive stock options that have a performance hurdle. Practical implications-The approach used in this paper to estimate the cost of granting executive stock options is a clear improvement over standard European option pricing approaches that often result in biased estimates. Originality/value-This paper presents a first attempt to integrate the Ingersoll utilitytheoretic model and the Longstaff and Schwartz least squares Monte Carlo algorithm to estimate the subjective value and the objective cost of executive stock options with a performance hurdle. This valuation approach will be useful in the study of other types of executive compensation. 1. The options have a strike price that drifts upward at a rate set with reference to a cost of capital estimate.

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Section: Introductionmentioning

confidence: 99%

The cost of granting executive stock options with strike prices adjusted by the cost of capital

Cheung

Corrado

2007

Pacific Accounting Review

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Explicit Relative Performance Evaluation in Performance-Vested Equity Grants

2008

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Using data from FTSE 350 firms, we examine factors influencing explicit relative performance evaluation (RPE) conditions in performance-vested equity grants. We provide exploratory evidence on whether the use or characteristics of RPE are associated with efforts to improve incentives by removing common risk, other economic factors discussed in the RPE literature, or external pressure to implement RPE. We find that many of these economic factors, including common risk reduction, are more closely related to specific relative performance conditions than to the firm-level decision to use RPE in some or all of their equity grants. We also find that greater external monitoring by institutional investors or others is associated with plans with tougher overall RPE conditions. The relative performance conditions are binding in most RPE plans, with nearly two-thirds of the grants vesting only partially or not vesting at all. Further, we find evidence that vesting percentages vary in RPE and non-RPE plans.Keywords restricted stock grant, equity plan, dividend playout ratio, stock option grant, compensation risk, RPE, equitybased pay, dividend yield, executive compensation contract, equity incentive, institutional investor, stock return volatility, London stock exchange, stock market performance, share price performance Abstract ______________________________________________________________________________ Using data from FTSE 350 firms, we examine the factors influencing the explicit use of relative performance evaluation (RPE) in performance-vested equity grants, and whether RPE is used to improve incentives or to opportunistically increase vesting and/or placate external parties calling for its use. We find little evidence that the simple decision to use or not use RPE is associated with the economic factors identified in RPE theories. Instead, these factors are associated with specific RPE performance conditions. The relative performance conditions are binding in most RPE plans, with nearly two-thirds of the grants vesting only partially or not vesting at all. However, we find no evidence that vesting percentages are higher in RPE plans than in non-RPE plans, and no evidence that RPE is used opportunistically to increase vesting and compensation.

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On Target: An Examination of CEO Stock Option Performance Hurdles

Cited by 2 publications

References 11 publications

The cost of granting executive stock options with strike prices adjusted by the cost of capital

The cost of granting executive stock options with strike prices adjusted by the cost of capital

Explicit Relative Performance Evaluation in Performance-Vested Equity Grants

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