Estimation of Employee Stock Option Exercise Rates and Firm Cost
30 Pages Posted: 9 Mar 2009
Date Written: February 2012
This paper is the ﬁrst to perform a comprehensive estimation of employee stock option ex- ercise behavior and option cost to ﬁrms. We develop a GMM-based methodology, robust to heteroskedasticity and correlation across exercises, for estimating the rate of voluntary option exercise as a function of the stock price path and of various ﬁrm and option holder character- istics. We use it to estimate an exercise function for a sample of 1.3 million employee-option grants to 530,266 employees at 103 publicly-traded ﬁrms between 1981–2009. We use the estimated exercise functions in a simulation based valuation model to analyze the eﬀect of diﬀerent ﬁrm and option characteristics on option value, and show that the Black-Scholes- based methods used in practice can create systematic biases.
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