The Effect of Executive Stock Option Plans on Stockholders and Bondholders

Authors

  • RICHARD A. DeFUSCO,

  • ROBERT R. JOHNSON,

  • THOMAS S. ZORN

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    • DeFusco is Assistant Professor of Finance, University of Nebraska-Lincoln. Johnson is Assistant Professor of Finance, Creighton University, and President JBK Capital Management, Inc. Zorn is The Rachel Parham Carveth College Professor of Finance and Associate Professor of Finance, University of Nebraska-Lincoln. The authors wish to thank Samuel H. Cox Jr., Gordon V. Karels, David Mayers, Manferd O. Peterson, Katrina Sherrerd, René M. Stulz, and an anonymous referee for helpful comments on earlier versions of this paper. The authors take responsibility for any errors.

ABSTRACT

Executive stock option plans have asymmetric payoffs that could induce managers to take on more risk. Evidence from traded call options and stock return data supports this notion. Implicit share price variance, computed from the Black-Scholes option pricing model, and stock return variance increase after the approval of an executive stock option plan. The event is accompanied by a significant positive stock and a negative bond market reaction. This evidence is consistent with the notion that executive stock options may induce a wealth transfer from bondholders to stockholders.

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