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

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