Employees’ Subjective Valuations of Their Stock Options: Evidence on the Distribution of Valuations and the Use of Simple Anchors

Posted: 15 Jul 2010

See all articles by Anne M. Farrell

Anne M. Farrell

Miami University Farmer School of Business - Department of Accountancy

Susan D. Krische

American University - Kogod School of Business

Karen Sedatole

Goizueta Business School

Multiple version iconThere are 2 versions of this paper

Date Written: July 13, 2010

Abstract

We examine employees’ subjective valuations of their stock options in terms of their distribution around firms’ opportunity cost of issuing options. Using both “real-world” and experiment data, we show that a significant proportion of employees (30 percent) and experiment participants (47 percent) apparently fail to fully incorporate the time-value component of option value, and instead anchor on three readily-available values, two of which lie below cost (zero value, intrinsic value) and one of which lies above (stock price). We further find that a stock option education program aimed at mitigating the tendency to disregard the time-value component leads to a significant change in valuations (in terms of both median values and dispersion) and lower reliance on simple anchors. Education that provides a qualitative description of an option-pricing model (i.e., cognitive feedback) has a significant effect on subjective valuations of additional options with differing characteristics, while education that provides quantitative option values (i.e., outcome feedback) has an effect on the valuations of original option holdings. Our study provides insight into the distribution of subjective valuations and how education programs can influence those valuations, thereby informing firms’ ESO cost-benefit analyses. Moreover, by examining the components of education, we show that effective education programs (i.e., with cognitive rather than outcome feedback) need not cross the boundaries of providing stock price projections that may cause liability concerns.

Keywords: Employee stock options (ESO), subjective valuation, anchors, Black-Scholes

JEL Classification: D02, D80, J33, M40, M52

Suggested Citation

Farrell, Anne M. and Krische, Susan D. and Sedatole, Karen, Employees’ Subjective Valuations of Their Stock Options: Evidence on the Distribution of Valuations and the Use of Simple Anchors (July 13, 2010). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1639627

Anne M. Farrell (Contact Author)

Miami University Farmer School of Business - Department of Accountancy ( email )

800 East High Street
3094 Department of Accountancy / MSC 1002
Oxford, OH 45056
United States

Susan D. Krische

American University - Kogod School of Business ( email )

4400 Massachusetts Ave NW
Washington, DC 20016
United States
202-885-2082 (Phone)
202-885-1992 (Fax)

Karen Sedatole

Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

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