THE INFORMATION CONTAINED IN THE EXERCISE OF EXECUTIVE STOCK OPTIONS

This paper investigates the use by insiders of private information in their decision to exercise executive stock options. It is the first to categorise the exercise of an executive stock option by the proportion of stock sold at exercise. Consistent with existing research, exercises overall do not yield subsequent abnormal returns. However, we find a marked and significant difference in subsequent performance between exercises categorised as ‘high’ and ‘low’ sale proportion respectively. Therefore, while the exercise decision may appear uninformed, this study demonstrates that executives do use private information in their exercise and corresponding sale decisions. Further, near-the-money exercises produce negative abnormal returns, consistent with such exercises being relatively expensive. These results need to be reflected in the valuation of executive stock options, and hence the compensation executives derive from them.