The benefits of stock options are often not large enough to offset the inefficiency implied by the large divergence between the cost of options to companies and the value of options to risk-averse, undiversified executives and employees. Moreover, the benefits of options can often be achieved...

We develop a model that clarifies how to measure CEO incentive strength and how to reconcile the enormous differences in pay sensitivities between executives in large and small firms. The crucial parameter is shown to be the elasticity of CEO productivity with respect to firm size. We find that...