Executive Stock Options: Value to the Executive and Cost to the Firm

61 Pages Posted: 27 Dec 2002 Last revised: 7 Nov 2010

See all articles by Ashay Kadam

Ashay Kadam

Goa Institute of Management

Peter Lakner

New York University (NYU) - Department of Information, Operations, and Management Sciences

Anand Srinivasan

National University of Singapore - Department of Finance; National University of Singapore (NUS) - Sustainable & Green Finance Institute (SGFIN)

Date Written: November 5, 2010

Abstract

We develop a continuous time utility-based model for valuing executive stock options (ESOs). We solve for the optimal exercise policy and the value of ESOs from an executive's perspective. Assuming ESOs to be perpetual and the executive to have Constant Absolute Risk Aversion, we derive explicit formulas for the optimal exercise price and the executive's value of a vested ESO. We also prove the verification theorem for the optimal stopping problem related to this valuation. Using the optimal exercise policy that emerges, we derive a simple formula for the cost of ESOs to the firm at the grant date. From an accounting perspective, this cost formula has the advantage of being transparent and straightforward to implement using data on previous ESO exercises. Using numerical analysis, we find that our model may provide cost estimates significantly lower than cost estimates found using the Black-Scholes-Merton model, especially for firms with low expected returns and high volatilities.

Keywords: executive stock options, executive compensations, accounting cost

JEL Classification: C61, G13, G30, J33, M12, M41, M52

Suggested Citation

Kadam, Ashay and Lakner, Peter and Srinivasan, Anand, Executive Stock Options: Value to the Executive and Cost to the Firm (November 5, 2010). Cass Business School Research Paper, Available at SSRN: https://ssrn.com/abstract=353422 or http://dx.doi.org/10.2139/ssrn.353422

Ashay Kadam (Contact Author)

Goa Institute of Management ( email )

Poriem
Goa
India

HOME PAGE: http://https://gim.ac.in/faculty/ashay-kadam

Peter Lakner

New York University (NYU) - Department of Information, Operations, and Management Sciences ( email )

44 West Fourth Street
New York, NY 10012
United States
212-998-0476 (Phone)

Anand Srinivasan

National University of Singapore - Department of Finance ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

National University of Singapore (NUS) - Sustainable & Green Finance Institute (SGFIN) ( email )

Singapore

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
721
Abstract Views
3,493
Rank
10,090
PlumX Metrics