Value Of Executive Stock Options Research Articles

Alternatives to Traditional Repricing of Executive Stock Options

The main purpose of this paper is to examine two commonly used alternatives to traditional repricing (TR) of executive stock options (ESOs) in a dynamic agency model. TR practices have become obsolete since new accounting rules took effect in July 2000. To avoid associated variable accounting charges that cause uncertainty in future reported earnings, companies have tried several TR alternatives as solutions to rescuing underwater options. We justify the occurrence of TR alternatives and quantify the impact of the marking-to-market feature imbedded in the new accounting rules. We also propose an incentive measure which is comparable to the subjective value of ESOs claimed by Ingersoll, J (2006) to rank TR alternatives in terms of agent's incentive.

EXECUTIVE STOCK OPTIONS AFTER ENRON: THEORIZING MANAGERIAL POWER WITHIN INSTITUTIONAL ENVIRONMENTS.

The article presents the results of research on changes to the value of executive stock options in the wake of corporate scandals, in terms of institutional theory. It focuses on the topics of mana...

Inattention, Forced Exercise, and the Valuation of Executive Stock Options

We develop a new Black-Scholes type closed-form valuation formula for executive stock options. This formula incorporates four important unique characteristics of these options that distinguish them from standard European options: (i) The presence of the vesting period; (ii) the tendency of executives to exercise portions of their grants right at the end of the vesting period; (iii) the ability of the executives to choose optimally whether to exercise their options or keep them; and (4) executives may be forced to early exercise their options, possibly due to severe liquidity shocks or due to unexpected departure. We use an extensive executive option data set to calibrate our model. We show that the standard Black-Scholes formula significantly overestimates the value of executive stock options.

Executive stock options and incentive effects due to systematic risk

Existing research on executive stock options mainly focuses on total risk when studying risk incentives. In this study, we use a GARCH option pricing framework to show that the incentive effects of executive stock options depend on the composition of risk. Controlling for total risk, the value of executive stock options increases with systematic risk and this effect is stronger when the total risk is low. Thus, when firms grant standard or non-indexed options, CEOs will have incentives to increase systematic risk even when the total risk remains constant. In contrast, indexed options will provide CEOs with incentives to reduce systematic risk. We therefore conclude that an optimal mix of indexed and non-indexed option grants will provide CEOs with incentives to take the desired level of systematic risk.

Quality of Earnings: An Introduction to the Issues in Accounting Education Special Issue

In September 1998, Arthur Levitt, then Chairman of the Securities and Exchange Commission (SEC), presented an address at New York University, Numbers Game. In that speech, he called attention to an escalating problem with the quality of financial reporting in filings with the SEC. The topic received a great deal of attention over the next several years, both at the SEC and in the business world at large; in the first six months of 2002 the quality of accounting reports has even been discussed in Congress. In 2000, pursuant to an SEC consent order under the Securities and Exchange Act of 1934, the American Accounting Association received a grant funding a multipart of Earnings Project. Recognizing the need to introduce future business professionals to the importance of quality early in their careers, one part of that project included funding for a special edition of Issues in Accounting Education. As stated in the call for papers to be considered for this special issue, submissions [wer e to] address some aspect of quality, and [could] be in financial accounting, managerial accounting, international accounting, auditing, systems, or tax....The overriding requirement [was] that the reader [would] be provided with ideas or materials about the quality of that he or she [could] take into the classroom. The seven cases included here are part of the response to that call. Additional manuscripts still in the review process will appear in Issues in Accounting Education, February 2003. Quality of earnings is a multidimensional concept. There are at least three distinct sets of decisions that affect the quality of earnings: decisions made by standard setters, choices made by management about which accounting methods should be chosen from a set of acceptable alternatives, and judgments and estimates made by management in order to implement the chosen alternatives. The set of accounting standards making up U.S. GAAP is generally considered to be of high quality. However, a perfect set of standards is unattainable due to the inherent tension between relevance and reliability of accounting numbers, and due to the changing nature of economic transactions over time. Even if it were possible for standard setters to agree on a single acceptable accounting alternative for every type of transaction, it might be inadvisable to do so. There may be valid reasons for allowing companies to choose among different allowed accounting alternatives. (Dechow and Skinner [2000], among others, discuss this issue in more depth.) For example, companies may enter into certain business transactions with different intents; allowing three different accounting treatments for certain investments in debt securities allows financial statements to reflect those different business objectives. Earnings management is a concept related to, but clearly not synonymous with, quality. Earnings management activities, broadly considered, can affect quality of on each of the three dimensions mentioned in the preceding paragraphs. Actions of participants in the standard-setting process that affect the quality of the allowed accounting standards could be considered management. For example, opposition to the FASB's proposed mandatory expensing of the fair value of executive stock options affected the quality of earnings. Similarly, managements' choices among allowed accounting alternatives also could be considered management. For example, decisions such as choosing the FIFO inventory cost-flow assumption in a period of increasing prices, or choosing to use straight-line depreciation, will result in earlier recognition of income, other things equal. Finally, as time passes and managements apply selected standards, when using judgments about whether criteria for recognition ha ve been met or whether estimates need revision, management may occur. …

Executive Stock Options: Value to the Executive and Cost to the Firm

We develop a continuous time utility-based model for valuing executive stock options (ESOs). We solve for the optimal exercise policy and the value of ESOs from an executive's perspective. Assuming ESOs to be perpetual and the executive to have Constant Absolute Risk Aversion, we derive explicit formulas for the optimal exercise price and the executive's value of a vested ESO. We also prove the verification theorem for the optimal stopping problem related to this valuation. Using the optimal exercise policy that emerges, we derive a simple formula for the cost of ESOs to the firm at the grant date. From an accounting perspective, this cost formula has the advantage of being transparent and straightforward to implement using data on previous ESO exercises. Using numerical analysis, we find that our model may provide cost estimates significantly lower than cost estimates found using the Black-Scholes-Merton model, especially for firms with low expected returns and high volatilities.

Valuing the Reload Features of Executive Stock Options

For options with a reload feature, the holder is automatically entitled to new options when the initial option is exercised. Under Statement of Financial Accounting Standards No. 123, the grant date value of executive stock options excludes the value of a reload feature because the Financial Accounting Standards Board believes it is not feasible to value a reload feature at the grant date. We show how the Binomial Option Pricing Model can be used to value options and the reload feature at the grant date. Ignoring the reload can substantially understate the value of the option. Accordingly, the Financial Accounting Standards Board may wish to reconsider the accounting for reload features.

Ignoring Reload Features Can Substantially Understate the Value of Executive Stock Options

Statement of Financial Accounting Standards No. 123 recommends that reload options be valued at the time the reload feature is activated and not at the time of the initial grant. We demonstrate that ignoring the reload feature at the time of the initial grant can substantially understate the value of the option granted. In the example we consider the reload feature increases the value of an otherwise similar option by 31 percent. We show how the Binomial Option Pricing Model can be used to value options with a reload feature at the time of the initial grant. In view of the potential significance of the reload feature and the versatility of the Binomial Option Pricing Model, the Financial Accounting Standards Board may wish to reconsider its recommendation regarding the valuation of the reload feature.

Companies' Modest Claims About the Value of CEO Stock Option Awards

This paper analyzes company disclosures of CEO stock option values in compliance with the SEC s regulations for reporting executive compensation data to stockholders. Companies appear to exploit the flexibility of the regulations to reduce the apparent value of managerial compensation. Companies shorten the expected lives of stock options and unilaterally apply discounts to the Black-Scholes formula. Theoretical support for these adjustments is often thin, and companies universally ignore reasons that the Black-Scholes formula might underestimate the value of executive stock options. The findings not only cast light upon how corporations value executive stock options, but also provide a means of forecasting compliance with controversial new FASB requirements for firms to disclose the compensation expense represented by executive stock options.

Measuring the Value of Executive Stock Options

Measuring the Value of Executive Stock Options

Accounting for executive stock options: Valuation alternatives for change

The use of stock options in executive compensation is encouraged by current accounting treatment, which in most cases does not result in compensation expense. Amid increasing public concern about executive compensation levels, FASB is returning its attention to proposals to revise the accounting rules for stock options. At the same time, the SEC is reconsidering its requirements for disclosing the value of executive stock options. In addition to reviewing the status of these projects, this article analyzes the option valuation models that might be used if new accounting or disclosure rules are adopted.