Executive valuation of simple compensation packages: the interaction of risk aversion, leverage and volatility

This paper analyses the value to a poorly diversified risk‐averse executive of a compensation package consisting of a risk free asset, restricted stock and stock options. The Lambert, Larcker and Verrecchia (1991) model is extended to include leverage and this facilitates comparison of cost to the firm and benefits to the executive of restricted stock and stock options. It also provides insight into the impact of executive risk aversion, firm leverage and underlying as set volatility on the value of a compensation package in the hands of the executive.