Optimal Stock Option Schemes for Managers

This paper analyzes which stock option scheme best aligns the interests of a firm's manager and shareholders when both are risk-averse. We consider granting to the manager a basic fixed salary and one of the following four options: European, Parisian, Asian and American options. Choosing the strike of the options optimally, the shareholders can mostly implement a first best solution with all payoff schemes. The American option scheme best aligns the interests of the manager and the shareholders in the most common case in which the strike price equals the grant-date fair market value