Inattention, Forced Exercise, and the Valuation of Executive Stock Options

24 Pages Posted: 17 Mar 2008 Last revised: 14 May 2014

See all articles by Hong Liu

Hong Liu

Washington University in St. Louis - Olin Business School; Fudan University - China Institute of Economics and Finance

Ohad Kadan

Washington University in St. Louis - John M. Olin Business School

Jun Yang

Indiana University - Kelley School of Business - Department of Finance

Date Written: February 15, 2009

Abstract

We develop a new Black-Scholes type closed-form valuation formula for executive stock options. This formula incorporates four important unique characteristics of these options that distinguish them from standard European options: (i) The presence of the vesting period; (ii) the tendency of executives to exercise portions of their grants right at the end of the vesting period; (iii) the ability of the executives to choose optimally whether to exercise their options or keep them; and (4) executives may be forced to early exercise their options, possibly due to severe liquidity shocks or due to unexpected departure. We use an extensive executive option data set to calibrate our model. We show that the standard Black-Scholes formula significantly overestimates the value of executive stock options.

Keywords: Executive Stock Options, Valuation

JEL Classification: G38, M52

Suggested Citation

Liu, Hong and Kadan, Ohad and Yang, Jun, Inattention, Forced Exercise, and the Valuation of Executive Stock Options (February 15, 2009). Available at SSRN: https://ssrn.com/abstract=1106409 or http://dx.doi.org/10.2139/ssrn.1106409

Hong Liu (Contact Author)

Washington University in St. Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)

Fudan University - China Institute of Economics and Finance ( email )

China

Ohad Kadan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Jun Yang

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3395 (Phone)
812-855-5875 (Fax)

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