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Heterogeneous beliefs and employee stock options

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Author Info
Wang, Jun (Baruch College)
Zhang, Ge (University of New Orleans)
Abstract

This paper uses a market valuation model to explore why firms grant employee stock options. When insider managers and outside investors have different opinions about the future prospects of the firm, employee stock options can be used to capture future investor overvaluation and to save employee compensation costs. Options can enhance the stock value for existing shareholders if the difference in opinion is highly volatile. The equilibrium option grant is positively correlated with both the perception error of investors, and the volatility of this error, as well as the correlation between investors 19 error and firm fundamental value. The model provides implications on the cross-sectional differences in option grants, and these implications can be examined empirically. 1 Introduction An employee stock option is an agreement between a firm and its employees under which the employees can buy a specified number of shares of stock at a specified price. Over the past decade, the use of employee stock options has been rising.

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Paper provided by University of New Orleans, Department of Economics and Finance in its series Working Papers with number 2003-14.

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Length: 46 pages
Date of creation: 15 Oct 2003
Date of revision:
Handle: RePEc:uno:wpaper:2003-14

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Keywords: Stock options; Market valuation;

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Find related papers by JEL classification:
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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    Other versions:
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  24. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors And Stock Option Exercise," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 601-627, May. [Downloadable!] (restricted)
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