The Intertemporal Exercise and Valuation of Employee Options

Abstract

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 theireffective costto the firm are significantly different from the predictions of aconstrainedmodel 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.