ERIM Research Seminar in Financial Management: "Incentive Effects of Performance-Vested Stock Options"
This paper assesses the incentive effects of stock options that link vesting to firm per- formance. It is shown that performance-vested stock options induce higher managerial e¤ort than traditional stock options (i.e. stock options that vest unconditionally) when performance targets are not too difficult. Furthermore, the principal is strictly better off when using performance-vested stock options. When performance targets reside at the optimal level, analysis indicates an above 70% vesting probability, echoing the con- sensus in the goal-setting literature that states that "tight, but achievable" targets are associated with performance benefits.