TY  - JOUR
AU  - Hall,Brian J.
AU  - Murphy,Kevin J.
TI  - Optimal Exercise Prices for Executive Stock Options
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7548
PY  - 2000
Y2  - February 2000
UR  - http://www.nber.org/papers/w7548
L1  - http://www.nber.org/papers/w7548.pdf
N1  - Author contact info:
Brian Hall
Harvard Business School
Baker Library 185
Boston, MA  02163
Tel: 617/495-5062
Fax: 617/496-7379
E-Mail: bhall@hbs.edu

Kevin M. Murphy
Booth School of Business
The University of Chicago
5807 S. Woodlawn Ave.
Chicago, IL  60637
Tel: 773/702-7280
Fax: 773/834-3554
E-Mail: murphy@chicagoBooth.edu
AB  - Although exercise prices for executive stock options can be set either below or above the grant-date market price, in practice virtually all options are granted at the money.  We offer an economic rationale for this apparent puzzle, by showing that pay-to-performance incentives for risk-averse undiversified executives are typically maximized by setting exercise prices at (or near) the grant-date market price. We provide an operationally useful alternative to Black-Scholes (1973) for the purpose of both valuing executive stock options and  measuring the incentives created by options. Our framework has implications not only for exercise-price policies, but also for indexed options, option repricings, exchanges of cash for stock-based compensation, and the design of bonus plans.
ER  -