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Pricing executive stock options under employment shocks

  • Carmona, Julio
  • León, Angel
  • Vaello-Sebastià, Antoni

We obtain explicit expressions for the subjective, objective and market value of perpetual executive stock options (ESOs) under exogenous employment shocks driven by an independent Poisson process. Previously, we obtain the executive's optimal exercise policy from the subjective valuation that is necessary for the objective one, or fair value. The perpetual ESO is compared with the true finite maturity ESO finding that the approximation is reasonably good. To illustrate the usefulness of the objective valuation for accounting purposes, we analyze the statistical distribution of the fair value when there is uncertainty about the employment shock intensity. Finally, the role of ESOs in the design of executives' incentives is also discussed.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 1 (January)
Pages: 97-114

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:1:p:97-114
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Jakša Cvitanić & Zvi Wiener & Fernando Zapatero, 2008. "Analytic Pricing of Employee Stock Options," Review of Financial Studies, Society for Financial Studies, vol. 21(2), pages 683-724, April.
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  8. Chang, Charles & Fuh, Cheng-Der & Hsu, Ya-Hui, 2008. "ESO compensation: The roles of default risk, employee sentiment, and insider information," Journal of Corporate Finance, Elsevier, vol. 14(5), pages 630-641, December.
  9. Kahl, Matthias & Liu, Jun & Longstaff, Francis A, 2001. "Paper Millionaires: How Valuable is Stock to a Stockholder Who is Restricted from Selling it?," University of California at Los Angeles, Anderson Graduate School of Management qt8b3853z9, Anderson Graduate School of Management, UCLA.
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  11. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
  12. Tian, Yisong S., 2004. "Too much of a good incentive? The case of executive stock options," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1225-1245, June.
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