Valuing Executive Stock Options: Performance Hurdles, Early Exercise and Stochastic Volatility

27 Pages Posted: 14 Aug 2008

See all articles by Philip R. Brown

Philip R. Brown

UWA Business School, M250; Financial Research Network (FIRN)

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration

Date Written: 2007-10-05

Abstract

Accounting standards require companies to assess the fair value of any stock options granted to executives and employees. We develop a model for accurately valuing executive and employee stock options, focusing on performance hurdles, early exercise and uncertain volatility. We apply the model in two case studies and show that properly computed fair values can be significantly lower than traditional BlackScholes values. We then explore the implications for pay-for-performance sensitivity and the design of effective share-based incentive schemes. We find that performance hurdles can require a much greater fraction of total compensation to be a fixed salary, if pre-existing incentive levels are to be maintained.

Suggested Citation

Brown, Philip R. and Szimayer, Alexander, Valuing Executive Stock Options: Performance Hurdles, Early Exercise and Stochastic Volatility (2007-10-05). Accounting & Finance, Vol. 48, Issue 3, pp. 363-389, September 2008. Available at SSRN: https://ssrn.com/abstract=1224073 or http://dx.doi.org/10.1111/j.1467-629X.2008.00259.x

Philip R. Brown

UWA Business School, M250 ( email )

Crawley, Western Australia 6009
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

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