ARTICLESNo Access

EXECUTIVE STOCK OPTIONS: A FIRM VALUE APPROACH

PHELIM BOYLE

Center for Advanced Studies in Finance, University of Waterloo, Waterloo, Ontario N2L 2Gl, Canada

Search for more papers by this author

and

WEIDONG TIAN

Deparment of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario N2L 2Gl, Canada

Search for more papers by this author

https://doi.org/10.1142/S0219868105000422Cited by:0 (Source: Crossref)

Abstract

Executive stock options are an important component of executive compensation and the topic is of interest to both practitioners and academics. The vigorous debate on whether these options should be treated as an expense is subsiding but discussion continues on how these instruments should be valued in order to expense them. In this paper, executive stock options are viewed as contingent claims on a firm's assets and we formalize this through the concept of an augmented balance sheet. This means that the total market value of the firm's assets is equal to the market value of its traded securities plus the market value of its stock options. This approach leads to two valuation formulae for these options: one in terms of the firm's stock price and the other in terms of firm value. We explore the connections between these two approaches and derive explicit valuation formulae under certain assumptions.

Keywords:

References

D. Aboody, Journal of Accounting and Economics 22, 357 (1996). Crossref, Google Scholar
L. A. Bebchuk and J. M. Fried, Journal of Economic Perspectives 17(3), 71 (2003). Crossref, Google Scholar
L. A. Bebchuk, J. M. Fried and D. I. Walker, University of Chicago Law Review 69(3), 751 (2002). Crossref, Google Scholar
Y. Bergman, B. Grundy and Z. Wiener, Journal of Finance 51(5), 1573 (1996). Crossref, Google Scholar
J. C. Bettis, J. M. Bizjak and M. L. Lemmon, Journal of Financial Economics 76(2), 445 (2005). Crossref, Google Scholar
F. Black and M. Scholes, Journal of Political Economy 81(3), 637 (1973). Crossref, Google Scholar
C. Botosan and M. Plumlee, Accounting Horizons 14(4), 311 (2001). Google Scholar
M. R. Brenner, R. Sundaram and D. Yermack, Journal of Financial Economics 57(1), 103 (2000). Crossref, Google Scholar
M. Broadie and J. B. Detemple, Review of Financial Studies 8(1), 161 (1995). Crossref, Google Scholar
Z. Bodie, R. Kaplan and R. Merton, Harvard Business Review 81, (2003). Google Scholar
Bodurtha, N. (2002). Dilution and multiple-issue tranches inherent in employee stock options valuation. Working Paper, The McDonough School of Business, Georgetown University . Google Scholar
J. Cai and A. Vijh, Journal of Derivatives (2005). Google Scholar
J. Carpenter, Journal of Financial Economics 48(2), 127 (1998). Crossref, Google Scholar
P. Carr and V. Linetsky, European Finance Review 4(3), 211 (2000). Crossref, Google Scholar
Chance, D. M. and T. -H. Yang (2004). Expected utility valuation of executive stock options in a binomial framework: a comparative anaylsis. Working Paper, Louisiana State University, Baton Rouge . Google Scholar
J. Core and W. Guay, Journal of Accounting and Economics 28(2), 151 (1999). Crossref, Google Scholar
J. Core and W. Guay, Journal of Financial Economics 61(2), 253 (2001). Crossref, Google Scholar
Darsinos, T. and S. E. Satchell (2002). The implied distribution for stocks of companies with warrants and/or executive stock options. Working Paper, Faculty of Economics and Politics, University of Cambridge . Google Scholar
H. Demsetz and K. Lehn, Journal of Political Economy 93(6), 1155 (1985). Crossref, Google Scholar
J. Detemple and S. Sundaresan, Review of Financial Studies 12(4), 835 (1999). Crossref, Google Scholar
J. Detemple and W. Tian, Management Science 48(7), 917 (2002). Crossref, Google Scholar
P. Dybvig and M. Loewenstein, Review of Financial Studies 16(1), 145 (2003). Crossref, Google Scholar
D. Emanuel, Journal of Financial Economics 12(2), 211 (1983). Crossref, Google Scholar
J. Ericsson and J. Reneby, Finance Letters 2, (2004). Google Scholar
Financial Accounting Standards (2004). 123(R), Share Based Payment . Google Scholar
D. Galai and M. Schneller, Journal of Finance 33(5), 1333 (1978). Crossref, Google Scholar
Garvey, G. and T. Milbourn (2001). Do stock prices incorporate the potential dilution of employee stock options? Working Paper, Graduate School of Management, Claremont Graduate University . Google Scholar
M. Hanlon, S. Rajgopal and T. Shevlin, Journal of Accounting and Economics 36(1–3), 3 (2003). Crossref, Google Scholar
B. Hall and K. Murphy, American Economic Review 90(2), 209 (2000). Crossref, Google Scholar
B. Hall and K. Murphy, Journal of Economic Perspectives 17(3), 49 (2003). Crossref, Google Scholar
C. Himmelberg, G. Hubbard and D. Palia, Journal of Financial Economics 53(3), 353 (1999). Crossref, Google Scholar
J. Hull and A. White, Financial Analysts Journal 60(1), 114 (2002). Crossref, Google Scholar
J. Hull and A. White, Journal of Derivative Accounting 1(1), 3 (2004). Link, Google Scholar
S. Huddart, Journal of Accounting and Economics 18(2), 207 (1994). Crossref, Google Scholar
International Accounting Standards (2004). IFRS 2, Share-Based Payment . Google Scholar
Johnson, S., H. Ryan and Y. Tian (2003). Executive compensation and corporate fraud. Working paper, Louisiana State University . Google Scholar
H. Leland, Journal of Finance 49(4), 1213 (1994). Crossref, Google Scholar
A. Marcus and M. Kulatilaka, Financial Analysts Journal 50(5), 46 (1994). Google Scholar
R. C. Merton, Journal of Finance 29(2), 449 (1974). Google Scholar
S. Rajgopal and T. Shevlin, Journal of Accounting and Economics 33(2), 145 (2002). Crossref, Google Scholar
M. Rubinstein, Journal of Derivatives 3, 8 (1995). Crossref, Google Scholar
J. Sidenius, Financial Analysts Journal 52(5), 77 (1996). Crossref, Google Scholar
D. Yermack, Journal of Finance 52(2), 449 (1997). Crossref, Google Scholar