The Influence of Risk Diversification on the Early Exercise of Employee Stock Options by Executive Officers

Abstract

This paper examines the decision to exercise employee stock options (ESOs). Our results indicate a positive relation between the extent of "early" exercise and the unhedged risk of the option. Specifically we document a positive relation between the variance of ESO returns and the extent of "early" exercise and show that the strength of the relation is reduced by the extent the firm hedges the returns on the ESO. We thus provide empirical evidence of a link between an ESO's expected term and its investment risk to the executive and document that some firms provide a hedge against option risk.

JEL Classification: J33