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Resolving the Agency Problems of External Capital through Options

Robert A. Haugen and Lemma W. Senbet
The Journal of Finance
Vol. 36, No. 3 (Jun., 1981), pp. 629-647
Published by: Wiley for the American Finance Association
DOI: 10.2307/2327523
Stable URL: http://www.jstor.org/stable/2327523
Page Count: 19
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Resolving the Agency Problems of External Capital through Options
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Abstract

This paper investigates the role of stock options in resolving the agency problems of external capital as originally identified by Jensen and Meckling (1976). These problems are precipitated by managerial incentives a) to consume excessive non-pecuniary benefits or perquisites beyond the optimal level for sole ownership and b) to engage in risk shifting in productive decisions so as to transfer wealth from external capital contributors. These incentive problems can be resolved through a strategy that judiciously combines call and put options retained by the owner-manager and external financiers, respectively. The resolution of the agency problems through this mechanism provides an economic rationale for the existence of managerial stock options and convertible debt.

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