On the benefits of allowing CEOs to time their stock option exercises

This article examines the costs and benefits of permitting executives to use inside information to time their stock option exercises. Whereas prior research has focused on the negative effects of timing discretion, I show that such discretion can have beneficial incentive effects in that it leads to improved project abandonment decisions. This result follows because at-the-money options used to induce managerial effort tilt the CEO's preferences toward project continuation. When the CEO is free to unload stock options at will, he will do so exactly in those states where the continuation bias is most detrimental (i.e., in the event of bad news), making the CEO willing to abandon the project. Copyright (c) 2010, RAND.