Employee Stock Options: Much More Valuable Than You Thought
AbstractPrevious papers have argued that trading restrictions can result in a typical employee stock option having a subjective value (certainty equivalent value) that is substantially less than its Black-Scholes value. However, these analyses ignore the manager’s ability to (at least partially) control the risk level within the firm. In this paper, we show how managerial control can lead to such options having much larger certainty equivalent values for employees who can exercise control. We also show that the potential for early exercise is substantially less valuable with managerial control. The certainty equivalent value for a European option with managerial control can easily exceed the Black-Scholes value for a comparable option without control. However, it is questionable whether Black-Scholes is an appropriate benchmark for an option where the underlying process exhibits controlled volatility. We show how to obtain a risk-neutral valuation for such an option. That risk-neutral value can be substantially greater or less than the Black- Scholes value. Furthermore, the option’s certainty equivalent value can also be greater or less than its risk-neutral value.
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Bibliographic InfoPaper provided by Center of Finance and Econometrics, University of Konstanz in its series CoFE Discussion Paper with number 05-01.
Length: 31 pages
Date of creation: 28 Feb 2005
Date of revision:
Other versions of this item:
- Jens Carsten Jackwerth & James Hodder, 2005. "Employee Stock Options: Much More Valuable Than You Thought," Working Papers wp05-09, Warwick Business School, Finance Group.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jens Carsten Jackwerth & James Hodder, 2005.
"Incentive Contracts and Hedge Fund Management,"
wp05-10, Warwick Business School, Finance Group.
- Jens Carsten Jackwerth & James E. Hodder, 2005. "Incentive Contracts and Hedge Fund Management," CoFE Discussion Paper 05-02, Center of Finance and Econometrics, University of Konstanz.
- Jackwerth, Jens Carsten & Hodder, James E., 2006. "Incentive Contracts and Hedge Fund Management," MPRA Paper 11632, University Library of Munich, Germany.
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