Executive Stock-Based Compensation: A Case Study in Valuing Employee Stock Options and Restricted Stock Issues in a Breach of Contract Case

Abstract

In this case study, the former CEO of a large telecommunication company filed a lawsuit against her former employer that alleged that the company’s contract breach resulted in the loss ESO grants and diminished the value of the vested ESOs that she held at the time of the alleged contract breach. The former company executive also alleges that the breach prevented her from receiving restricted company stock shares that she believes she was entitled to under her contract with the employer. In this paper, I present an application of the Shapiro and O’Connor (2001) modified Black-Scholes (B-S) and the Hull-White (2002) binomial lattice tree employee stock option (ESO) valuation models to the valuation of breach of employment contract damages. In addition to ESO valuation, this paper also illustrates the valuation of restricted company stock issues and provides a discussion of the approaches used to account for the unique valuation related issues that arise in litigation. The case study illustrates the importance of incorporating case specific factors, such as the plaintiff's historical ESO exercise rates and firm specific ESO forfeiture probabilities, into the valuation models.