Impacts of future compensation on the incentive effects of existing executive stock options

- Future pay affects the incentive effects of stock options that have been granted.
- We explain why firms grant options repeatedly to executives.
- We should consider the effects of future compensation when designing pay packages.

This paper analyzes the impact of compensation offered in the future on the incentive effects of executive stock options that have already been granted. I show that in many cases, subsequent compensation in the form of options is more likely to maintain the incentive effects of existing options than the subsequent grant of cash salaries or stock. The numerical results explain why firms continue to grant options repeatedly to executives. I suggest that, when designing pay packages or estimating the sensitivity of executive pay to firm performance, we should consider the impact of future compensation.