A Model for Valuing Multiple Employee Stock Options Issued by the Same Company

University of North Carolina Kenan-Flagler Business School Working Paper

38 Pages Posted: 16 Apr 2003

See all articles by Patrick J. Dennis

Patrick J. Dennis

University of Virginia - McIntire School of Commerce

Richard J. Rendleman

University of North Carolina at Chapel Hill

Date Written: January 23, 2004

Abstract

Current techniques employed in valuing multiple employee stock options issued by the same company treat each option as being independent of the others and do not reflect that the option values should be determined simultaneously. In this paper we develop a model to simultaneously value all employee options issued by the same firm and study the valuation impact associated with ignoring this simultaneity when more conventional approaches to employee option valuation are used. Using a set of valuation examples, we demonstrate that if each employee stock option is issued on a small to moderate fraction of a firm's outstanding shares, the standard Black-Scholes/binomial and multiple employee option-pricing models give values that are not materially different from each other. However, if employee options are issued on a larger portion of outstanding shares, using the Black-Scholes/binomial approach can result in mis-valuation on the order of 25 percent. Therefore, in cases for which there is the potential for significant equity dilution resulting from the exercise of employee options, there can be a material difference between option values computed via the multiple employee option-pricing model and those computed using more standard option valuation methods.

JEL Classification: G12, G13, G32, C63

Suggested Citation

Dennis, Patrick J. and Rendleman, Richard J., A Model for Valuing Multiple Employee Stock Options Issued by the Same Company (January 23, 2004). University of North Carolina Kenan-Flagler Business School Working Paper, Available at SSRN: https://ssrn.com/abstract=375500 or http://dx.doi.org/10.2139/ssrn.375500

Patrick J. Dennis (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
804-924-4050 (Phone)

Richard J. Rendleman

University of North Carolina at Chapel Hill ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-3188 (Phone)
919-962-0054 (Fax)

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