A General Framework for Evaluating Executive Stock Options

Abstract

Motivated by recent recommendations by both European and American accounting standards boards that executive stock options be expensed in firms' statements, we provide an analytical and flexible framework for their evaluation. Our approach takes into account the vesting period, American style, resetting and reloading provisions that are features of many options programs, and also considers the trading restriction on executives. We identify a recursive structure in the stream of options that are granted to the executive over the course of her employment. By exploiting this, we are able to obtain a near-explicit formula for the option value. This enablesus to discuss the joint effects of the different features on the exercising strategies and firms' granting cost. Especially, we highlight some significant interactions among these features.

Keywords: Executive stock options; Reloading; Repricing; Trading and hedging restrictions; Vesting period

JEL Classification: G13, J33, G30, M41