A Stock Option Based Incentive Scheme with an Endogenous Strike Price.

This paper examines the implications of corporate manager's tendency to promote her private benefits by realizing inefficient investments that incurs a cost for shareholders in terms of lost shareholder value. Under reasonable conditions, we derive an expression for such a loss and propose a compensation scheme providing an incentive to avoid inefficent investments. The scheme amends the well-established linear incentive scheme with a call option, the strike price of which is endogenously determined by the scale of corporate investment as well as investment returns in alternative equally risky projects.