Optimal Equity Based Incentives: A Norwegian Perspective

Abstract

We analyze optimal executive compensation in a principal agent framework using two sample firms from the Norwegian market, design and solve a bi-level principal agent optimization problem. Our analysis reports three important findings. First, our unambiguous results shows that stock options should be a part of the optimal contract in addition to a certain base salary. The options, rather than restricted shares produce the right incentives. Second, indexed options should be granted instead of traditional options in cases where firms have a volatility higher than the market index and where it is a good correlation between those two. Third, our solutions show that exercise price of options should be at or near the stock price at the granting time. We confirm the robustness of our model by optimizing for alternative risk aversion degrees of the CEOs and the disutility factor associated with their effort.