The rationales for, and benefits of, executive stock options are explored in this article. Executive stock options provide the means for aligning managerial and shareholder interests. This is achieved by the introduction of incentive structures that lead managers to make decisions which causes an increase in the shareholder value. The conditions for designing the contracts are discussed and analyzed.

Around 25 years ago or so there was considerable debate as to the harmony between executive remuneration and corporate performance. That is, is the remuneration that executives receive highly elastic with regards to the achieved corporate performance? This dimension was also linked with the governance notions associated with the distinction between the ownership and control of the corporation. Executive stock options were suggested as one potential solution to these problems and the usage of such options has increased dramatically over the period of time such that more than half of the remuneration of executives in the largest US corporations comes from executive stock options. In this short article, I will address a number of issues pertinent to the use and management of executive stock options in a succinct fashion.

As much of the corporate finance literature assumes that decisions are made within a firm with the objective of increasing shareholder value, any scheme which attempts to align managerial and stockholder interests should ensure that the shareholder value is maximized. Clearly the managerial holding of stock would be one way of ensuring an alignment between the potentially conflicting objectives of managers and shareholders. However, executive stock options will also have values oriented towards the underlying value of the stock. In this case furthermore, given that options are levered products, they will magnify the effects of increases in stock values in terms of executive remuneration. In this way it would be anticipated that issuing stock options would increase the elasticity of remuneration to performance. Indeed, it has been found that the introduction of executive stock options doubles this elasticity relative to the holding of stock alone. Some authors also draw out the distinctions between holding stock and having executive stock options granted via the former relating to the current situation while the latter are more strongly-oriented towards the future.

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