On Employee Stock Options
Date Issued
2010
Date
2010
Author(s)
Wu, Che-Yu
Abstract
This paper discusses the behavior of an employee who receives employee stock options (ESOs) and trades on the market portfolio. We propose a discrete time utility maximization model to nd the employee behavior and the value of the ESOs to the employee. Since the ESOs holder is not allowed to trade company stocks and he is risk averse, the unhedgeable rm risk leads ESOs to have less value than ordinary options.
We fi nd the formula for the investment strategies and the value of the ESOs, both European style and American style . An increase in the correlation between the stock and the market portfolio decreases the amount of investment in the
market portfolio, and an increase in risk aversion ecreases the value of the ESOs to the employee. Also if the employee is more risk averse he will exercise the ESOs earlier. Our model gives these results directly.
Subjects
binomial tree models
utility maximization
employee stock options
Type
thesis
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