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The first section of this chapter discusses the basic features of option contracts, with special reference to stock options, including the way in which the contractual elements of an option (such as the maturity or exercise price) have been standardized to facilitate trading. The second section examines various methods of valuing options contracts and how the value of a option will be influenced by its maturity, striking price, market interest rates and the price of the underlying security; it also explores the ways in which call and put options may be combined to form various types of ‘spreads’ and ‘straddles’. The last three sections are quite short: the third briefly analyzes the way in which options might be used to hedge a portfolio of stocks, and hence their role as a risk management tool; the fourth explains how the shares in a levered firm can themselves be viewed as a type of option, and the implications of this for the pricing of stocks; and the last discusses options on objects other than stocks. The examples given refer to the USA and Europe.

Option markets reflect all three behavioral themes. The chapter is organized around the way options are (1) used; (2) priced; and (3) reflect investor sentiment. The chapter begins with the popular ways investors use options, where frame dependence figures prominently. The focus is on covered call writing, but also discusses how employees make decisions about exercising company stock options. In discussing pricing, the discussion emphasizes the relationship between investors' expectations about future volatility, so called “implied volatility,” and actual volatility. The point here is that heuristic‐driven bias moves implied volatility away from its objective counterpart. In other words, heuristic‐driven bias causes option markets to be inefficient. The chapter discusses two related phenomena that stem from the effect the 1987 stock market crash had on implied volatility. One is known as “crashophobia,” and the other is known as the “crash premium.” The chapter ends with a discussion about the influence investor sentiment has had on patterns of option trading.

This chapter presents a fundamental component of every firm's internal control system, its compensation program. The basic paradigm espoused by the proponents of VBM is that what a firm measures and rewards will get done. Consequently, the compensation program must measure employees’ activities that contribute toward wealth creation and reward those efforts. In essence, the compensation plan should pay employees to think and act like owners. Both the level of compensation and its form and composition are discussed. Many observed problems and potential remedies are presented. One characteristic that firms must be aware of is the public's perception that executive compensation has become unacceptably excessive. A complete V_sBM program must consider the political implications of its behavior as these perceptions can and do effect a firm's reputation and ultimately its wealth-creating ability. One mechanism for addressing these perceptions is to consider fairness criteria when designing a compensation program.

This chapter aims to provide a review and update on some important questions in employee stock options. Several reasons are mentioned as to why learning about stock options is important for firms, employees, and public policymakers. The past twenty years are stated to have seen a dramatic growth in the use of stock options for senior-level executives, and, beginning in the mid-1990s, substantial growth in the use of options for nonexecutive employees that was only partially dampened by the market adjustment in 2001. Another reason is that it may provide insight into the widespread debate about the appropriate method of estimating the cost and value of options to firms. There are many strongly held opinions and new Financial Accounting Standards Board regulations on how firms should expense options, although there is no consensus on a theoretical or empirical method for estimating employee stock option costs to the firm.

This chapter recounts Noyce's departure from Fairchild Semiconductor and his decision to launch a new company with Gordon Moore, which they named Intel. Noyce and Moore wanted potential investors to know that the company intended to fund both a stock option plan and a stock purchase plan for employees. The founders believed that stock ownership was the best guarantee of both loyalty and innovation.

Previous chapters have focused on the pricing of bonds and assets with payments determined by future interest rates. This chapter studies the impact of the shape and the dynamics of the yield curve on the prices of securities with payments that depend on other random variables. The present value of a security involves the discounting of the future payments, and the appropriate discount factors depend on the interest rate uncertainty as well as the correlations between interest rates and the random variables that determine the payments of the security. Particular focus is on the pricing of stock options allowing for stochastic interest rates — in contrast to the classic Black-Scholes-Merton model. General results on the pricing of options on forwards or futures are derived. The pricing of forwards, futures, and European options on a foreign currency is also discussed.

The chapter provides a comprehensive transatlantic comparison of pay spanning six years and covering approximately 1,500 US firms and 900 firms from nine European countries with mandated pay disclosures. The authors show that US CEOs are paid significantly more than their foreign counterparts after controlling for company size, industry, and other characteristics. Moreover, US executives receive a greater share of their compensation in the form of stock options, restricted shares, and performance-based bonuses. In the end, the authors present the evolution in the UK, France, Germany, and Italy.

This chapter addresses the nature and complications of executive stock options (ESO). Executives seek ESO grants, but do not want the concentrated exposure of the risk to their firms. They would prefer the cash value of the options and are often willing to settle for the much lower intrinsic value of the options that they can secure by exercising. Exercises lessen the executive's incentives and often lead to the firm's replenishing the executive's option position by issuing new options.

This chapter addresses several questions surrounding employee stock ownership as a wealth-sharing tool. It discusses how much on average do employee owners own in “shared capitalist” firms (those with broad-based employee ownership, profit sharing, gain sharing, and/ or stock options). It explores how company stock distributed among employee-owners, which ownership structures distribute wealth most equitably, and how the distribution of employee stock ownership wealth compares to the distribution of wealth among US households. Further, the extent of employer stock substitute for other forms of compensation (higher pay and benefits) and for other forms of wealth is discussed. It also describes the effect of universal employee ownership of employer stock on the overall distribution of stock ownership and pension wealth in the United States. Results indicated that broad-based employee ownership may be raising wealth for many workers without unduly increasing worker risk.

This chapter analyzes the CEO's pay package and how different elements play an incentivizing role. The typical executive pay package consists of many elements with different effects on the executive's incentives. Of the various elements of pay, the equity portion is the main vehicle through which the firm seeks to give the executive incentives for long-term value maximization. The two principal equity vehicles are “restricted stock” and “executive stock options” (ESO). The restricted stock is straightforward in design with a purely linear payoff structure, while ESOs are much more complicated.

This chapter introduces a social structure of accumulation (SSA) theoretical framework for comparing and contrasting the institutional norms of the post-World War II period and the era of global neoliberalism. The SSA framework suggests that periods of growth require a coherent set of mutually reinforcing institutions favorable to capital accumulation. These involve the creation of relatively lasting accommodations between contesting social forces, including stable understandings between capital and labor, the United States and the rest of the world, capital and the state, capitalists and other capitalists, and citizens and their government. Institutional stability provides conditions under which the behavior of others, the meaning of events, and the likely outcome of actions can be predicted over the relevant planning horizon with enough confidence to provide consistent expectations, and so encourage investment and promote growth. This chapter examines the financialization and commercial banking that have accompanied major periods of economic restructuring, the change in significance of stock options over the neoliberal era, the use of accounting for corporate profits, and the restructuring of financialization.

This chapter examines how various constituencies interact and respond to the incentive-compensation schemes that firms adopt. The major elements of the CEO pay package that vary with the current year's stock market results are the value of the CEO's restricted stock and executive stock options (ESO) holdings. The value of ESOs and restricted stock strongly vary with day-to-day stock price movements, but cash receipts by the CEO may not be directly linked to stock price movements. If a CEO sells formerly restricted stock or exercises vested ESOs when the stock market is down, receipts from the sources may be high when the stock market is performing poorly.

This chapter analyzes the relationship of shared capitalism programs to a range of employee outcomes: participation in decisions, supervision, training, company treatment of employees, pay, job security, and job satisfaction by using the General Social Survey (GSS) and NBER data sets. Profit sharing is stated to be most consistently linked to the positive outcomes, although gain-sharing, stock options, and employee ownership also affect some outcomes positively. In many cases the positive effect was tied to simply being covered by a policy, but there were also many cases in which the effect was tied to the size of the financial stake involved. Those who are covered by the combination of high-performance policies with shared capitalism are most likely to report high participation in decisions, satisfaction with participation, and overall job satisfaction. The combination of close supervision with shared capitalism, however, has negative effects on almost every outcome.

This chapter provides two practical applications of the legal theory of the firm elucidated in the book. One controversial issue addressed is executive compensation in corporations, which many observers believe has become disproportionate in some countries and within some firms. The chapter shows how some influential economic theories adopted simplistic “principal–-agent” prescriptions which contributed to imbalance and injustice in contemporary compensation practices (e.g. through the careless use of stock options). An institutional legal theory offers a corrective to this approach.A second controversial issue involves the political free-speech rights of corporations and other “business persons,” such as addressed in the controversial Citizens United case. The chapter argues that an institutional legal theory of the firm can deepen analysis and understanding on both sides of the debate. It also suggests possible directions for future compromise, such as mandatory disclosure requirements of the funding of political campaigns and other political activities of business firms.

For more than two decades, the United Kingdom has tried to encourage shared capitalist practices by offering tax advantages to firms that link pay to profits, provide company shares to workers, encourage workers to save through stock options, or develop approved share-option plans. Behind the desire to increase shared compensation in the United Kingdom is the widespread belief that shared capitalist arrangements will create a better work culture with improved productivity and commitment by employees. Existing studies on profit sharing, employee ownership, and employee participation lend general support to this proposition, but these studies also show considerable variability in the effects of practices on firm performance. This chapter examines how a shared mode of compensation has affected firm performance in the United Kingdom. It uses a 1999 survey of the shared compensation strategies used by a sample of UK listed companies between 1995 and 1998; the 1998 Workplace Employment Relations Survey (WERS) of some 2,000 UK establishments or workplaces; and the 1990–1998 longitudinal WERS panel survey of nearly 900 workplaces.

One of a board’s most important roles is setting executive pay. This chapter introduces the various components of executive compensation schemes and analyzes the pay-setting process using the efficient contracting hypothesis. Executives and the board bargain over how sensitive pay will be to the firm’s performance, weighing the incentives generated by performance-based pay against the misallocation of risk that results when risk that could be diversified away by shareholders is transferred onto a firm’s executives. Executives and the board also negotiate over the level of pay, leading to outcomes that reflect the strength or weakness of the board. This chapter uses the story of Michael Eisner’s compensation during the 21 years he was Disney’s CEO to explain the efficient contracting hypothesis and to illustrate the problems that can arise when executives’ compensation is closely tied to a firm’s performance.

Manager-shareholder conflict arises due to low levels of managerial ownership and the resulting wide separation of ownership and control. However, strong boards of directors can make even small ownership stakes more effective at motivating executives to work in shareholders’ best interests by granting stock options, repurchasing shares, and issuing debt. Ultimately they can approve a leveraged buyout, although a strong board is needed to overcome the conflicts of interest involved in management-led buyouts. This chapter uses events at HCA, the for-profit hospital chain that undertook the world’s largest leveraged buyout followed a few years later by the largest private equity IPO, to explain how boards can narrow the gap between ownership and control. It uses a novel representation of a firm’s capital structure to analyze the techniques for boosting ownership-generated incentives at relatively low cost to shareholders.