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Valuing executive stock options: performance hurdles, early exercise and stochastic volatility

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  • Philip Brown
  • Alex Szimayer
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    Abstract

    Accounting standards require companies to assess the fair value of any stock options granted to executives and employees. We develop a model for accurately valuing executive and employee stock options, focusing on performance hurdles, early exercise and uncertain volatility. We apply the model in two case studies and show that properly computed fair values can be significantly lower than traditional Black-Scholes values. We then explore the implications for pay-for-performance sensitivity and the design of effective share-based incentive schemes. We find that performance hurdles can require a much greater fraction of total compensation to be a fixed salary, if pre-existing incentive levels are to be maintained. Copyright (c) 2008 The Authors. Journal compilation (c) 2008 AFAANZ.

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    Bibliographic Info

    Article provided by Accounting and Finance Association of Australia and New Zealand in its journal Accounting & Finance.

    Volume (Year): 48 (2008)
    Issue (Month): 3 ()
    Pages: 363-389

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    Handle: RePEc:bla:acctfi:v:48:y:2008:i:3:p:363-389

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    Cited by:
    1. Len, Angel & Vaello-Sebasti, Antoni, 2009. "American GARCH employee stock option valuation," Journal of Banking & Finance, Elsevier, vol. 33(6), pages 1129-1143, June.
    2. Carmona, Julio & León, Angel & Vaello-Sebastiá, Antoni, 2011. "Does Stock Return Predictability Affect ESO Fair Value?," QM&ET Working Papers 11-2, Universidad de Alicante, Departamento de Métodos Cuantitativos y Teoría Económica, revised 16 Jan 2012.

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