Tax Planning and the Exercise of Employee Stock Options*

Abstract

AbstractThis paper analyzes tax planning by holders of employee stock options and examines their response to a proposed tax rate increase. Consistent with tax planning, the frequency of exercise is greater for employees affected by the tax change than for (1) employees unlikely to be affected by the tax increase who contemporaneously held identical options, and (2) employees with comparable incomes who held similar options in other years. Despite the greater frequency of exercise, less than one‐third of the option holders who would benefit most from exercise for tax reasons chose to exercise early.