Estimating the Cost of Executive Stock Options: evidence from Switzerland


*Wolfgang Drobetz, Chair of Corporate Finance and Ship Finance, University of Hamburg, Von-Melle-Park 5, 20146 Hamburg, Germany. Phone: +49-40-42838-5506; E-mail:


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