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Stock Options: Are They Worth What Their Price?

9 Pages Posted: 16 May 2005  

Óscar E. Carbonell López

Universidad Panamericana - Instituto Panamericano de Alta Dirección de Empresa (IPADE)

Date Written: May 2004

Abstract

The Stock Options have become one of the most commonly used instruments in the executives' compensation packages. Nevertheless, the cost to the firm of the Stock Options, usually, is much higher than its value to the executives. One of the reasons for this discrepancy is that there is no secondary market for Stock Options, which, means that it is forbidden to sell them - and additionally, the majority of the executives lack the possibility of forming a portfolio with the same payoffs and sell it. Therefore, it prevents the executives from doing arbitrage and their expectations about the evolution of the stock's prices are relevant, which in turn in the eyes of the executives further lowers the value of the Stock Option. We have developed a very simple model, in which on one side we have calculated the cost of the options to the firm by utilizing traditional formulas and on the other side we have worked with the formula Binomial but it includes a Certainty Equivalent Wealth function. We find that - depending on degree of risk aversion, the value of the option perceived by the executive is much lower than the cost that the firm bears for the same option.

Keywords: Stock options, compensation

JEL Classification: C13, J33

Suggested Citation

Carbonell López, Óscar E., Stock Options: Are They Worth What Their Price? (May 2004). Available at SSRN: https://ssrn.com/abstract=723221 or http://dx.doi.org/10.2139/ssrn.723221

Óscar E. Carbonell López (Contact Author)

Universidad Panamericana - Instituto Panamericano de Alta Dirección de Empresa (IPADE) ( email )

Floresta 20, Col. Clavería
Delegación Azcapotzalco 02080
Mexico
52 55 53 990083 (Phone)
52 55 53 99 7682 (Fax)

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