This paper by Brian J. Hall and Kevin J. Murphy analyzes the cost and value of non-tradable stock options held by undiversified, risk-averse executives using a certainty-equivalence framework. The authors derive "Executive Value" lines, which are the risk-adjusted analogues to Black-Scholes lines, and distinguish between "executive value" and "company cost." They demonstrate that the divergence between the value and cost of options explains various issues related to stock option practice, including executive views on Black-Scholes measures, trade-offs between options, stock, and cash, exercise price policies, connections between pay-setting and exercise price policies, institutional investor views, option repricings, early exercise policies, and vesting periods. The paper also reinterprets cross-sectional facts and longitudinal trends in executive compensation levels. The authors argue that traditional option-pricing formulas like Black-Scholes overstate the value of options to executives, leading to higher demands for cash premiums and influencing pay-setting and exercise price policies. They further explore the incentives created by non-tradable executive options and suggest that common prescriptions, such as setting higher performance hurdles with premium options, may not be in the shareholders' best interest. The paper concludes with implications for the design of employee bonus plans and the overall structure of executive compensation.This paper by Brian J. Hall and Kevin J. Murphy analyzes the cost and value of non-tradable stock options held by undiversified, risk-averse executives using a certainty-equivalence framework. The authors derive "Executive Value" lines, which are the risk-adjusted analogues to Black-Scholes lines, and distinguish between "executive value" and "company cost." They demonstrate that the divergence between the value and cost of options explains various issues related to stock option practice, including executive views on Black-Scholes measures, trade-offs between options, stock, and cash, exercise price policies, connections between pay-setting and exercise price policies, institutional investor views, option repricings, early exercise policies, and vesting periods. The paper also reinterprets cross-sectional facts and longitudinal trends in executive compensation levels. The authors argue that traditional option-pricing formulas like Black-Scholes overstate the value of options to executives, leading to higher demands for cash premiums and influencing pay-setting and exercise price policies. They further explore the incentives created by non-tradable executive options and suggest that common prescriptions, such as setting higher performance hurdles with premium options, may not be in the shareholders' best interest. The paper concludes with implications for the design of employee bonus plans and the overall structure of executive compensation.