ABSTRACT
STOCK OPTIONS HAVE BECOME AN increasingly important component of executive compensation, and are used by most Fortune 500 firms to compensate their senior executives. In an extensive review, Murphy (1998, p. 21) states that “The most pronounced trend in executive compensation in the 1980s and 1990s has been the explosion of stock option grants, which on a Black-Scholes basis now constitute the single largest component of executive pay.” The most frequently cited explanation for granting options is their incentive effect. Options create a direct link between management compensation and shareholder wealth and thereby align the interests of a firm’s managers with those of its shareholders.
