Employee Stock Option Valuation with an Early Exercise Boundary
Posted: 24 Sep 2008
Date Written: September, 23 2008
Abstract
Many companies are recognizing that the Black-Scholes formula is inappropriate for employee stock options (ESOs) and are moving toward lattice models for accounting or decision-making purposes. In the most influential of these models, the assumption is that employees exercise voluntarily when the stock price reaches a fixed multiple of the strike price, effectively introducing a horizontal exercise boundary into the lattice. In practice, however, employees make a trade-off between intrinsic value captured and the opportunity cost of time value forgone. The model proposed here explicitly recognizes and accounts for this reality and is intuitively appealing, easily implemented, and compliant with U.S. accounting standards. Editor's Note: The paper on which this article is based won the Second Annual Best Conference Research Paper Award from the Canadian Finance Executives Research Foundation at the 2008 Financial Executives International (FEI) Canada conference.
Keywords: Financial Statement Analysis, Accounting and Financial Reporting Issues, Equity Investments, Fundamental Analysis and Valuation Models, Corporate Finance, Other
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