Inside Information and the Exercise of Employee Stock Options: New Evidence

Abstract

Owners of employee stock options can convert future stock appreciation from ordinary income to long-term capital gains if they exercise their options and subsequently hold the acquired shares for one year and one day. This provides an incentive for the early exercise of employee stock options if the owner is sufficiently optimistic about future stock performance. We examine the period 1997-2000 for Form 4 filings in which officers and directors exercised employee stock options more than one year before expiration and then held a majority of the acquired shares. We find statistically significant positive abnormal returns in the months subsequent to the option exercise suggesting that favorable private information guided the timing of the exercise.

Keywords: Employee stock options, private information

JEL Classification: G11, G13, G14