Working Paper: NBER ID: w11950
Authors: Kevin F. Hallock; Craig A. Olson
Abstract: This study empirically investigates the value employees place on stock options using information from the option exercise behavior of individuals. Employees hold options for another period if the value from holding them and reserving the right to exercise them later is higher than the value of exercising them immediately and collecting a profit equal to the stock price minus the exercise price. This simple model implies the hazard describing employee exercise behavior reveals information about the value to employees of holding options another time period. We show the parameters of this model are identified with data on multiple option grants per employee and we apply this model to the disposition of options received in the 1990s by a sample of over 2000 middle-level managers from a large, established firm outside of manufacturing. Exercise behavior is modeled using a random effects probit model of monthly exercise behavior that is estimated using simulated maximum likelihood estimation methods. Our estimates show there is substantial heterogeneity (observed and unobserved) among employees in the value they place on their options. Our estimates show most employees value their options at a value greater than the option's Black-Scholes value.
Keywords: stock options; employee compensation; exercise behavior
JEL Codes: J3; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| employees value their stock options higher than the Black-Scholes value (D46) | employees exhibit irrational overvaluation of their options (J29) |
| exercise behavior reveals significant heterogeneity among employees (J29) | employees value their stock options higher than the Black-Scholes value (D46) |
| early exercise of options contradicts traditional Black-Scholes predictions (G13) | employees value their stock options higher than the Black-Scholes value (D46) |
| average employee's value of holding an option exceeds its intrinsic value (D46) | employees value their stock options higher than the Black-Scholes value (D46) |