Optimal Exercise of Executive Stock Options and Implications for Valuation

22 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 2005

Abstract

The cost of executive stock options to shareholders has become a focus of attention in finance and accounting. The difficulty is that the value of these options depends on the exercise policies of the executives. Because these options are nontransferable, the usual theory does not apply. We analyze the optimal exercise policy for a utility-maximizing executive and indicate when the policy is characterized by a critical stock price boundary. We provide a counterexample in which the executive exercises at low and high stock prices but not in between. We show how the policy varies with risk aversion, wealth, and volatility and explore implications for option value. For example, option value can decline as volatility rises.

Suggested Citation

Carpenter, Jennifer N. and Stanton, Richard H. and Wallace, Nancy E., Optimal Exercise of Executive Stock Options and Implications for Valuation (December 2005). NYU Working Paper No. FIN-05-047. Available at SSRN: https://ssrn.com/abstract=1294190

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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