The effects of option incentives on research and development investment

This paper examines how various elements of CEOs' option portfolios create conflicting incentives on research and development investment decisions. Incentives from unexercised vested options are shown to have an increasing effect on R%D investment, whereas the effect of incentives from unexercised unvested options is non-monotonic. In particular, R%D investment initially increases with incentives from unvested options and then decreases afterwards. Similarly, newly granted options have a non-monotonic effect when CEOs do not retain any unvested options in their portfolios. However, for an average firm where unvested options have been accumulated at a high level, adding new granted options only has a decreasing effect on R%D. The effects of various option elements on R%D investment can be explained by a combination of an incentive alignment effect and a risk diversification effect.