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Valuing Employee Stock Options: Implications for the Implementation of NZ IFRS 2

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  • Boyle, Glenn
  • Clyne, Stefan
  • Roberts, Helen

Abstract

From 2007 New Zealand firms must report the cost of granting employee stock options (ESOs). Market-based option pricing models assume that options are continuously tradable and thus that option holders are indifferent to the specific risk of the firm. ESOs by contrast cannot be traded and so their cost depends on the risk aversion and under-diversification characteristics of the recipient. Using hypothetical ESOs we show that ESO cost is extremely sensitive to employee characteristics thereby casting doubt on the usefulness of any market-based model. Incorporating early exercise in the latter does nothing to resolve this problem because the optimal exercise policy is itself dependent on holder characteristics which are typically unobservable. Vesting restrictions help reduce the magnitude of error.

Suggested Citation

  • Boyle, Glenn & Clyne, Stefan & Roberts, Helen, 2005. "Valuing Employee Stock Options: Implications for the Implementation of NZ IFRS 2," Working Paper Series 18949, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    • Handle: RePEc:vuw:vuwcsr:18949
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    File URL: https://ir.wgtn.ac.nz/handle/123456789/18949
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    References listed on IDEAS

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    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    2. Carpenter, Jennifer N., 1998. "The exercise and valuation of executive stock options," Journal of Financial Economics, Elsevier, vol. 48(2), pages 127-158, May.
    3. Huddart, Steven, 1994. "Employee stock options," Journal of Accounting and Economics, Elsevier, vol. 18(2), pages 207-231, September.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Lally, Martin & Marsden, Alastair, 2004. "Tax-adjusted market risk premiums in New Zealand: 1931-2002," Pacific-Basin Finance Journal, Elsevier, vol. 12(3), pages 291-310, June.
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