Share Option Rewards and Managerial Performance: an Abnormal Performance Index Model

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Abstract
Managerial share option schemes are widely used as a means of motivating and rewarding corporate performance. Such schemes normally adopt a static exercise price; when additional exercise criteria are employed they are often based on earnings per share. A static exercise price does not adjust for economic changes outside the control of management, and earnings per share hurdles have similar limitations. This paper presents a ‘phantom’ managerial option based on relative performance, together with a pricing model for the valuation of the option. The option is developed and demonstrated using an abnormal performance index. It offers a structure which could be used for different forms of performance measurement, and resolves some important criticisms of the reward and incentive effects of traditional schemes.

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