Belief in the law of small numbers

Abstract

We analyze how 14, 000 top U.S. executives exercise their stock options. Factors suggested by existing theories have low or moderate explanatory power. Variables that model executives’ motive to diversify fare particularly poorly, whereas variables that capture reference-dependent preference, such as past highs and lows of stock prices, perform better. By contrast, characteristics of option portfolios are of first-order importance and suggest that managers have target ownership levels. Institutional features like vesting restrictions or blackout periods also have a first-order impact. We conclude that executives’ main motivations for exercising stock options early seem to be outside the scope of extant models. (JEL G30, M52)Received August 20, 2018; editorial decision December 28, 2019 by Editor Andrew Ellul.

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