Option Exercise Behavior Research Articles

Uncertainty avoidance and the timing of employee stock option exercise

We examine the impact of the cultural norm of uncertainty avoidance on employee stock option (ESO) exercise behavior using proprietary data from a multinational firm. We find that employees from countries with higher levels of uncertainty avoidance exercise their stock options earlier. These findings lend support to a maintained assumption in the ESO literature that employee attitudes toward uncertainty influence stock option exercise behaviors. Our findings further help to explain prior findings of cross-cultural differences in firms’ compensation practices by indicating that employee responses to option-based pay and firms’ consequent financial reporting costs vary as functions of employee uncertainty avoidance.

Cashing-in: understanding post-acquisition CEO stock option exercise

Purpose– The purpose of this study is to explore post-acquisition compensation management and examine how the two most commonly used theories to explain CEO stock option exercise, agency theory and CEO overconfidence, expect CEOs to manage their stock options following an acquisition.Design/methodology/approach– Using logistic regression analysis, the authors investigate whether CEOs are more or less likely to exercise options following an acquisition, and the effect which CEO tenure and acquisition history may have on option exercise.Findings– The results suggest that CEOs are more likely to exercise options following an acquisition. The authors also find that CEO tenure and acquisition experience are both linked to an increase in option exercise.Research limitations/implications– The findings suggest that future research should expect agency effects to outweigh overconfidence effects when considering CEO stock option exercise behavior within the post-acquisition firm context.Practical implications– This paper advises directors and shareholders about whether agency concerns or overconfidence are of greater concern and how CEO tenure and past acquisition history may influence post-acquisition CEO stock option exercise behavior, offering information valuable in designing effective corporate governance.Originality/value– This paper is among the first to explore how CEOs manage their options following an acquisition and finds that CEOs are more likely to exercise stock options following an acquisition. Post-acquisition compensation management is an important, though overlooked, consideration in improving acquisition performance.

Employee stock option-implied risk attitude under Rank-Dependent Expected Utility

Probability weighting is one of the cornerstones of decision-making theories accommodating gambling preferences. This paper examines its relevance to explaining employee stock option exercise behavior. We characterized the optimal exercise policy for a representative employee with Rank-Dependent Expected Utility (RDEU) preferences. We find that the RDEU framework leads to improved predictions of empirical exercise patterns. The implications from our findings are twofold: (1) probability weighting implies an increase in stock option cost to shareholders; (2) employee exercise behavior-implied sentiment is affected by the firm's stock market risk and performance.

CEO optimism and incentive compensation

I study the effect of chief executive officer (CEO) optimism on CEO compensation. Using data on compensation in US firms, I provide evidence that CEOs whose option exercise behavior and earnings forecasts are indicative of optimistic beliefs receive smaller stock option grants, fewer bonus payments, and less total compensation than their peers. These findings add to our understanding of the interplay between managerial biases and remuneration and show how sophisticated principals can take advantage of optimistic agents by appropriately adjusting their compensation contracts.

Behavioral Differences between Founder CEOS and Professional CEOS: The Role of Overconfidence

We provide evidence that founder CEOs of large SP they are also more likely to perceive their firm to be undervalued as implied by their option-exercise behavior. To date, investors appear unaware of the “overconfidence bias” among founders.

CEO Optimism and Incentive Compensation

I study the effect of chief executive officer (CEO) optimism on CEO compensation. Using data on compensation in US firms, I provide evidence that CEOs whose option exercise behavior and earnings forecasts are indicative of optimistic beliefs receive smaller stock option grants, fewer bonus payments, and less total compensation than their peers. These findings add to our understanding of the interplay between managerial biases and remuneration and show how sophisticated principals can take advantage of optimistic agents by appropriately adjusting their compensation contracts.

CEO Optimism and Incentive Compensation

I study the effect of chief executive officer (CEO) optimism on CEO compensation. Using data on compensation in US firms, I provide evidence that CEOs whose option exercise behavior and earnings forecasts are indicative of optimistic beliefs receive smaller stock option grants, fewer bonus payments, and less total compensation than their peers. These findings add to our understanding of the interplay between managerial biases and remuneration and show how sophisticated principals can take advantage of optimistic agents by appropriately adjusting their compensation contracts.

CEO Overconfidence or Stock Mispricing and Growth? Reexamining the Effect of CEO Option Exercise Behavior on Corporate Investment

CEO Overconfidence or Stock Mispricing and Growth? Reexamining the Effect of CEO Option Exercise Behavior on Corporate Investment

CEO Overconfidence or Stock Mispricing and Growth? Reexamining the Effect of CEO Option Exercise Behavior on Corporate Investment

CEO Overconfidence or Stock Mispricing and Growth? Reexamining the Effect of CEO Option Exercise Behavior on Corporate Investment

CEO Overconfidence or Stock Mispricing and Growth? Reexamining the Effect of CEO Option Exercise Behavior on Corporate Investment

Malmendier and Tate (2005) use CEO late option exercise to proxy for unobservable CEO overcon…dence and argue that managerial overcon…dence can account for investment distortion. Consistent with CEO rationality, this paper provides an alternative explanation to their …ndings. By breaking the market-to-book ratio into …rm mispricing, industry mispricing and growth opportunity, I …nd that industry mispricing and growth opportunity in‡uence both CEO option exercise and corporate investment. When …rms are overvalued or have better growth opportunities, CEOs are more likely to postpone their option exercise and at the same time invest more using internal cash. Moreover, CEO late option exercise fails to explain investment decisions after controlling for mispricing and growth opportunity. These …ndings suggest that CEO’s personal portfolio decision may not be an appropriate proxy for managerial overcon…dence.

Executive Stock Options with Consumption and Partial Exercise

Finance researchers are placing increasing emphasis on executive option exercise behavior as a window into executive preferences and beliefs. This paper models an executive's option exercise problem in a realistic setting, with a particular emphasis on identifying exercise determinants. To this end, we allow executives to partially exercise options. This flexibility is moderately valuable to executives and costly to companies. It also can induce substantial differences in empirically observable measures of executive option exercise behavior. We show that executives' relative risk aversion and liquid wealth are critical exercise determinants. Using a model in which executives with Epstein-Zin preferences also choose consumption, we also show that the elasticity of intertemporal substitution plays a minimal role in exercise decisions and valuation, even for very long-dated options. The sensitivity of exercise behavior to risk aversion and wealth suggests that empirical studies relying on option exercise to identify executive beliefs may benefit from carefully controlling for these factors.

Timing of Employee Stock Option Exercises and the Cost of Stock Option Grants

This study examines how executives' and lower-level employees' option exercise behavior affects firms' stock option grant cost estimates. Prior research suggests that option grant cost estimates are not materially different when calculated a using utility-based model or a risk-neutral model adjusted for historical exercise rates. This study shows, however, that estimates of exercise times are significantly improved when the model accounts for behavioral and economic determinants of option exercise such as the attainment of performance benchmarks, recent vesting, the intrinsic value of an employee's option portfolio, and employee rank. Hazard analysis of all executive and employee option grants within a proprietary sample of firms yields lower out-of-sample exercise timing prediction errors relative to utility-based models and estimates using historical exercise patterns. More importantly, option cost estimates are materially different when improved estimates of exercise times are used, which may have implications for financial reporting.

The Intertemporal Exercise and Valuation of Employee Options

We propose a multiperiod model to value employee options allowing for the possibility that a risk-averse employee strategically exercises her options over time rather than at a single date. Our results describing the representative employee's option exercise behavior are broadly consistent with existing empirical evidence. The value of options to the employee and their effective cost to the firm are significantly different from the predictions of a constrained model that assumes “single date” strategic option exercise. The constrained model substantially underestimates the cost of options to the firm when, ceteris paribus, the employee's relative risk aversion and/or the time to maturity and/or the stock volatility exceed respective thresholds. Hence, the incorporation of “multiple-date” exercise has important economic and accounting consequences.

THE EFFECT OF TAXES ON THE TIMING OF STOCK OPTION EXERCISE

This paper examines whether stock option exercise behavior is consistent with the incentives provided by the US Internal Revenue Code using data provided by a large multinational corporation which made multiple broad-based and management grants over the period of examination. In particular we examine whether holders delay exercising their options to transfer income from one year to the next, hence deferring the tax payments associated with the option gains. We document that taxpayers rationally delay the exercise of taxable nonqualified options around the end of the year, consistent with the incentive to delay tax payments. In contrast we do not find this pattern with respect to the exercise of qualified stock options, upon which taxes may be indefinitely deferred.