Incentive Stock Options Incentive Mechanism And Its Performance Explanations

Executive stock option and making manager an inside shareholder is a new incentive mechanism widely used in western countries to mitigate principal-agent problems. Although utilizing such mechanism has achieved great success in corporation practices, economists never stop their suspicions on it. Foreign economists either discuss this issue from the perspective of principal-agent theory or from corporation finance theory, but they never get consensus with each other and whether this mechanism would increase corporation value or not is remain to be a controversial topic in academic domain. On the other hand, domestic economists are discussing this issue under the confliction of classic political economics of Marx and western main trend economics, the only thing they could do is to argue about the basic concepts and definitions and it is meaningless for us to understand the essence of this incentive system. It is obvious that we could not use this method to solve the principal-agent problem in Chinese enterprises permanently before we could clarify the working mechanism of this incentive system and testify it with positive research. That constitutes exactly what this dissertation concerns.The author thinks that economic resources are allocated simultaneously in two aspects: in capital market it is the allocation of capital fortune, and in the corporation it is the allocation of producing materials. The first allocation process is determined by the transactions in capital market and the latter one is at the disposal of corporation managers. So the secondary stock market prices, which is often viewed as the most "informationally efficient" prices in the economy, would have no direct role in the allocation of equity capital since managers have discretion in determining the level of investment because there is no incentive to induce managers to react upon such information.What is the link between stock price informational efficiency and economic efficiency? This dissertation present a model of the stock market in which: managers have discretion in making investments and must be given the right incentives and the stock market traders may have important information that managers do not have about the value of prospective investment opportunites and retrospective manager working exertions. In equilibrium, information in stock prices will not only guide investment decisions but also help the shareholders to evaluate manager's work precisely: this all because managers compensation is linked with stock prices of the company and theinformation flow between capital market and managers are made possible. So we can realize the stock market efficiency and economic efficiency simultaneously by utilizing stock incentives to the corporation managers. In the model, the author gives out requirements for the manager's compensational contract to satisfy the incentive compatibility and incentive constraint to induce managers to join such information producing and transferring process. By this way, we could reach Pareto dominance of economic resources allocation and maximize the value of the corporation.After depicting the mechanism of incentive system with our model, we discuss about making manager an inside shareholder would hamper competitive markets producing external pressure on corporate governance and thus would decrease corporation value. The author testifies this hypothesis by positive research on certain listed company in China and gives out theoretical explanations on research outcomes.Finally, the author probes into the practices of Chinese enterprises in utilizing stock incentives system to its managers and certain suggestions is given for the constitution of more efficient incentive system in China.