Some authors argue that one way to control the conflicts of interests between managers and stockholders is to give stock options to managers. How can we explain this argument using the simple model of section 3.1.1? What other factors should be included in this analysis?

Data From Section 3.1.1:-

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Consider a firm where the manager owns a fraction of the equity. This manager-owner will make operating decisions maximizing the joint effect of two different sources of utility. The manager's utility will be assumed to be generated not only by the benefits derived from pecuniary returns, but also by some nonpecuniary aspects of the manager's activity. Examples of nonpecuniary aspects are the physical appointments of the office, the kind and amount of contributions to charity, attractiveness of the staff, nature of personal relationship with employees, and an excellent computer. When the owner-manager sells equity to outsiders, a typical agency problem arises because of the difference of interests between him/her and the outside shareholders. Consider a firm generating a flow with present market value V, and let F denote the market value of the stream of the manager's expenditures on nonpecuniary benefits. This reduces the effective value of the firm to V = V - F. If the owner-manager holds a fraction a of the shares of the firm, its utility will be described by the real function U(aV, F), which is increasing and concave in both arguments. In this context, two main results are in order. First, given an optimal choice of F, utility to the owner-manager decreases as new equity is issued. Second, the effective value of the firm decreases. In fact, the decline in the value of the firm is entirely imposed on the owner-manager. This is reflected in the decrease of his/her utility.