Estimation of Employee Stock Option Exercise Rates and Firm Cost: Methodology

26 Pages Posted: 3 Nov 2008

See all articles by Jennifer N. Carpenter

Jennifer N. Carpenter

New York University (NYU) - Department of Finance

Richard Stanton

University of California, Berkeley - Haas School of Business

Nancy Wallace

University of California, Berkeley - Real Estate Group

Date Written: December 2006

Abstract

Investors have become increasingly concerned about the cost of executive stock options to shareholders. Because executives face hedging constraints, standard option theory does not apply. The valuation problem reduces to accurately characterizing the option payoff. This paper develops a methodology for estimating option exercise and cancellation rates as a function of the stock price path, time to expiration, and firm and option holder characteristics. Our estimation accounts for correlation between exercises by the same executive. Valuation proceeds by using the estimated exercise rate function to describe the option's expected payoff along each stock price path and then computing the present value of the payoff. The estimation of empirical exercise rates also allows us to test the predictions of theoretical models of option exercise behavior. The paper not only illustrates an ideal valuation method for a large dataset, but also shows how to evaluate the usefulness of some of the approximations proposed in the literature.

Suggested Citation

Carpenter, Jennifer N. and Stanton, Richard H. and Wallace, Nancy E., Estimation of Employee Stock Option Exercise Rates and Firm Cost: Methodology (December 2006). NYU Working Paper No. FIN-06-043. Available at SSRN: https://ssrn.com/abstract=1293665

Jennifer N. Carpenter (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0352 (Phone)
212-995-4233 (Fax)

Richard H. Stanton

University of California, Berkeley - Haas School of Business ( email )

Haas School of Business
545 Student Services Building #1900
Berkeley, CA 94720-1900
United States
(510) 642-7382 (Phone)
(510) 643-1412 (Fax)

Nancy E. Wallace

University of California, Berkeley - Real Estate Group ( email )

Berkeley, CA 94720-1900
United States

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