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Heterogeneous beliefs and employee stock options

Author

Listed:
  • 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.

Suggested Citation

  • Wang, Jun & Zhang, Ge, 2003. "Heterogeneous beliefs and employee stock options," Working Papers 2003-14, University of New Orleans, Department of Economics and Finance.
    • Handle: RePEc:uno:wpaper:2003-14
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    More about this item

    Keywords

    Stock options; Market valuation;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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