Estimating the Cost of Executive Stock Options: Evidence from Switzerland

It is often argued that Black-Scholes (1973) values overstate the subjective NEWLINE value of stock options granted to risk-averse and under-diversified executives. NEWLINE We construct a “representative” Swiss executive and extend the certainty- NEWLINE equivalence approach presented by Hall and Murphy (2002) to assess NEWLINE the value-cost wedge of executive stock options. Even with low coefficients NEWLINE of relative risk aversion, the discount can be above 50% compared to the NEWLINE Black-Scholes values. Regression analysis reveals that the equilibrium level NEWLINE of executive compensation is explained by economic determinant variables NEWLINE such as firm size and growth opportunities, whereas the managers’ pay-forperformance NEWLINE sensitivity remains largely unexplained. Firms with larger NEWLINE boards of directors pay higher wages, indicating potentially unresolved NEWLINE agency conflicts. We reject the hypothesis that cross-sectional differences in NEWLINE the amount of executive pay vanish when risk-adjusted values are used as NEWLINE the dependent variable

Due diligence, research joint ventures, and incentives to innovate

The decision to cooperate within R&D joint ventures is often based on `expert advice.' Such advice typically originates in a due diligence process, which assesses the R&D joint venture's profitability, for example, by appraising the achievability of synergies. We show that if the experts who advise the owners considering forming an R&D joint venture are also responsible for R&D efforts, they can have incentives to withhold information about the extent of those synergies. Owners optimally react by reducing the incentives to innovate in low-value projects developed within R&D joint ventures and in high-value projects developed within competing research organizations