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http://ssrn.com/abstract=353422
 
 

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


Ashay Kadam


Cass Business School Faculty of Finance

Peter Lakner


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

Anand Srinivasan


National University of Singapore - Department of Finance

November 5, 2010

Cass Business School Research Paper

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.

Number of Pages in PDF File: 61

Keywords: executive stock options, executive compensations, accounting cost

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

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Date posted: December 27, 2002 ; Last revised: November 7, 2010

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: http://ssrn.com/abstract=353422 or http://dx.doi.org/10.2139/ssrn.353422

Contact Information

Ashay Kadam (Contact Author)
Cass Business School Faculty of Finance ( email )
106 Bunhill Row
London, EC1Y 8TZ
Great Britain
+44 20 7040 8632 (Phone)
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
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