A brief overview of executive stock options in reducing the agency problem of excessive risk aversion

Abstract

Purpose – The purpose of this paper is to discuss how executive stock options help in reducing agency costs in the firm and to address problems experienced by the firm when stock options are used as incentives. Design/methodology/approach – The paper initially discusses types of agency problems caused by company managers and then explains why stock options can reduce the problem of excessive risk aversion displayed by some managers. It then addresses the problems that may occur with the introduction of executive stock options by the firm and finally offers methods to reduce these problems. Findings – The paper explains the methods available to reduce the problems caused by executive stock options such as indexing the stock options to the S&P 500 index and structuring the Board of Directors in a manner that helps ensure the stock options are used appropriately. Originality/value – This paper is valuable to firms using executive stock options as incentives to managers. It outlines the problems stock options can help solve and the problems which may occur by their use. In addition, the ways to reduce the problems produced by executive stock options in the firm are discussed.