Stock options and chief executive officer compensation, discussion paper

Dye, Kenneth Judd and Madhav Rajan were especially helpful. Che-Lin Su is grateful for financial support from the NSF (award no. SES-0631622) Stock Options and Chief Executive Officer Compensation Although stock options are commonly observed in chief executive officer (CEO) com-pensation contracts, there is theoretical controversy about whether stock options are part of the optimal contract. Using a sample of Fortune 500 companies, we solve an agency model calibrated to the company-specific data and we find that stock options are almost always part of the optimal contract. This result is robust to alternative assumptions about the level of CEO risk-aversion and the disutility associated with their effort. In a supplementary analysis, we solve for the optimal contract when there are no restrictions on the contract space. We find that the optimal contract (which is characterized as a state-contingent payoff to the CEO) typically has option-like features over the most probable range of outcomes. i Stock Options and Chief Executive Officer Compensatio