Option Compensation, Accounting Choice and Industrial Competition

Because of recent corporate frauds and scandals the use of options as a compensation device has become a controversial subject. In this paper we take a new look at the issue, by contrasting the use of options with that of pure stock. We do this by integrating the repricing or resetting aspect of options with that of industrial structure and accounting issues. We show that options may be correlated with recent tendencies toward overly conservative accounting practices. In addition, industry competition may play an important role in dictating which form of compensation is optimal. When aggressive competition for key professional staff is an issue, the flexibility of options may actually become a disadvantage and therefore pure stock compensation may survive as an equilibrium.