Do Firms Grant Options in Order to Balance Risk Incentives?

Brian D. Cadman
University of Oregon

Abstract: This paper examines the grant of employee stock options in response to changes in the CEO option portfolio. I document a positive relation between option grants and the probability of the option portfolio expiring “in the money” for a CEO whose option portfolio has a high probability of expiring “in the money”. I show that this positive relation does not exist for CEOs whose option portfolio does not have a high probability of expiring “in the money”. I also provide evidence suggesting that firms grant options with a positive relation to the change in the sensitivity of the option portfolio value to changes in stock price. I thus provide empirical evidence of a link between a firm granting stock options to a CEO and the probability of his option portfolio expiring “in the money” and document that firms consider the probability of the option portfolio expiring “in the money” and the sensitivity of the portfolio to changes in stock price when aligning CEO risk incentives with shareholders.

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