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Employee stock options

Steven Huddart

This paper examines the valuation of employee stock options (ESOs). Because ESOs are inalienable, the employee's optimal exercise policy differs from the policy a naive reading of the finance literature would suggest. The employee prefers to exercise options before maturity under certain conditions on risk aversion, investment opportunities, and wealth. Since the ESOs' cost to the employer depends on the employee's exercise policy, this finding has implications for changes to the accounting treatment of ESOs under consideration by the Financial Accounting Standards Board. Numerical examples suggest the employer's cost is much less than the options' Black-Scholes value.

Journal of Accounting & Economics Volume 18, Number 2 (September 1994) 207-231

Econbase abstract for this paper

Keywords: management compensation, stock options, exercise policy, valuation.

JEL Classification: G12 M41 C61

Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
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