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Hanken School of Economics Working Papers, Hanken School of Economics

No 498:
What Determines Stock Option Contract Design?

Daniel Pasternack () and Matts Rosenberg ()

Abstract: This paper analyzes factors driving the design of stock option plans for Finnish firms. We examine determinants of the scope of plans, exercise price, target group, and dividend protection. The scope is found to be negatively related to Tobinís Q and positively related to proxies for monitoring costs. The scope is also greater in broad-based plans, and in plans with dividend protection. Prior stock return is found to be negatively related to the size of the premium (out-of-the-moneyness), whereas dividend protection increases the premium. The results also suggest that investment intensity, cash flow, and monitoring costs are associated with the likelihood of granting premium (out-of-the-money) stock options. Furthermore, the likelihood of granting broad-based plans is increasing in institutional ownership and cash flow constraints, and decreasing in firm size. Broad-based plans are also more likely among firms in growth industries. We find support that the likelihood of dividend protection is decreasing in foreign ownership. In addition, firms paying zero-dividends are less likely to include dividend protection, whereas higher unsystematic risk is associated with a greater likelihood of including dividend protection.

Keywords: Stock option contract design; Optimal contracting; Agency costs; (follow links to similar papers)

44 pages, June 19, 2003

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