How do Executives Exercise Their Stock Options

Abstract We analyze how 14,000 US top executives exercise their stock options. We investigate competing explanatory approaches to identify the main variables that influence executives' timing decisions. We find that the predictions specific to utility theory are not supported by the data. Managers seem to see through investor sentiment and select rationally from their exercisable options. Exercise decisions depend on past stock prices in a way that is consistent with reference dependence, whereas we find inconsistent evidence for trend extrapolation. Characteristics of managers' option portfolios and institutional factors (vesting dates, blackout periods) have a first-order impact on exercise behavior, whereas timing based on inside information is quantitatively less important. Our overall conclusion is that managers' behavior is rational with only small or infrequent errors, but their preferences are not well described by conventional utility theory.