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Valuation Of Employee Reload Options Using Utility Maximization Approach

Author

Listed:
  • KA WO LAU

    (Department of Computer Science, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China)

  • YUE KUEN KWOK

    (Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China)

Abstract

The reload provision in an employee stock option is an option enhancement that allows the employee to pay the strike upon exercising the stock option using his owned stocks and to receive new "reload" stock options. The usual Black–Scholes risk neutral valuation approach may not be appropriate to be adopted as the pricing vehicle for employee stock options, due to the non-transferability of the ownership of the options and the restriction on short selling of the firm's stocks as hedging strategy. In this paper, we present a general utility maximization framework to price non-tradeable employee stock options with reload provision. The risk aversion of the employee enters into the pricing model through the choice of the utility function. We examine how the value of the reload option to the employee is affected by the number of reloads outstanding, the risk aversion level and personal wealth. In particular, we explore how the reload provision may lower the difference between the cost of granting the option and the private option value and improve the compensation incentive of the option award.

Suggested Citation

  • Ka Wo Lau & Yue Kuen Kwok, 2005. "Valuation Of Employee Reload Options Using Utility Maximization Approach," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(05), pages 659-674.
    • Handle: RePEc:wsi:ijtafx:v:08:y:2005:i:05:n:s0219024905003189
    DOI: 10.1142/S0219024905003189
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