Employee Stock Options: Much More Valuable Than You Thought
Previous 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.
(This abstract was borrowed from another version of this item.)
|Date of creation:||2005|
|Date of revision:|
|Contact details of provider:|| Postal: Coventry, CV4 7AL|
Phone: +44 (0)24 76524118
Fax: +44 (0)24 76524167
Web page: http://web.warwick.ac.uk/fac/soc/financeRepec/
More information through EDIRC
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.:
- Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
- Jennifer Carpenter, 1997.
"The Exercise and Valuation of Executive Stock Options,"
New York University, Leonard N. Stern School Finance Department Working Paper Seires
97-10, New York University, Leonard N. Stern School of Business-.
- Carpenter, Jennifer N., 1998. "The exercise and valuation of executive stock options," Journal of Financial Economics, Elsevier, vol. 48(2), pages 127-158, May.
- 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.
- Jens Carsten Jackwerth & James Hodder, 2005. "Incentive Contracts and Hedge Fund Management," Working Papers wp05-10, Warwick Business School, Finance Group.
- Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
- Huddart, Steven, 1994. "Employee stock options," Journal of Accounting and Economics, Elsevier, vol. 18(2), pages 207-231, September.
- Detemple, Jerome & Sundaresan, Suresh, 1999. "Nontraded Asset Valuation with Portfolio Constraints: A Binomial Approach," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 835-72.
When requesting a correction, please mention this item's handle: RePEc:wbs:wpaper:wp05-09. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Rong Leng)
If references are entirely missing, you can add them using this form.