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SOCIAL SCIENCE RESEARCH NETWORK
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 7, No. 15: June 09, 2006
Editor: PAMELA J. PERUN
Urban Institute
PAMELA@PLANETNOW.COM
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Topic of This Issue:
Stock Options
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T A B L E O F C O N T E N T S
"The Value of Stock Options to Non-Executive Employees"
KEVIN F. HALLOCK
University of Illinois at Urbana-Champaign, National
Bureau of Economic Research (NBER)
CRAIG A. OLSON
University of Illinois at Urbana-Champaign -
Institute of Labor and Industrial Relations (ILIR)
"Microsoft's Employee Option Buyback"
DON M. CHANCE
Louisiana State University, Baton Rouge - E.J. Ourso
College of Business Administration
"Employees' Perceived Value of Their Stock Option Holdings: How
Training Affects the Cost-Value Gap"
ANNE M. FARRELL
University of Illinois at Urbana-Champaign
SUSAN D. KRISCHE
University of Illinois at Urbana-Champaign -
Department of Accountancy
KAREN L. SEDATOLE
Eli Broad College of Business
"Efficiency of Employee Stock Option Taxation and Disclosure"
MICHAEL NWOGUGU
Independent
"Transfer Pricing and Employee Stock Options"
AMIN MAWANI
York University - Department of Accounting
MARSHA L. REID
Deloitte & Touche, LLP
"CEO Stock Options and Equity Risk Incentives"
MELISSA A. WILLIAMS
University of Houston, Clear Lake - School of
Business and Public Administration
RAMESH P. RAO
Oklahoma State University - Stillwater - Department
of Finance
"Stock Options and the Corporate Demand for Insurance"
LI-MING HAN
Washington State University
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"The Value of Stock Options to Non-Executive Employees"
NBER Working Paper No. W11950
Contact: KEVIN F. HALLOCK
University of Illinois at
Urbana-Champaign, National Bureau of Economic
Research (NBER)
Email: hallock@uiuc.edu
Auth-Page: http://ssrn.com/author=16001
Co-Author: CRAIG A. OLSON
University of Illinois at
Urbana-Champaign - Institute of Labor and
Industrial Relations (ILIR)
Email: COLSON@BUS.WISC.EDU
Auth-Page: http://ssrn.com/author=62011
Full Text: http://ssrn.com/abstract=877455
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.
______________________________
"Microsoft's Employee Option Buyback"
Contact: DON M. CHANCE
Louisiana State University, Baton
Rouge - E.J. Ourso College of Business
Administration
Email: dchance@lsu.edu
Auth-Page: http://ssrn.com/author=30031
Full Text: http://ssrn.com/abstract=746726
ABSTRACT: In the second half of 2003 Microsoft undertook a
program that offered employees holding certain deep
out-of-the-money options the opportunity to turn over these
options to JPMorgan Chase and receive cash. Employees were
required to decide whether to tender their options before knowing
how much they would receive, an amount determined by an averaging
process over a future time period with a reduction in the time to
expiration. The tendered options would be turned into standard
over-the-counter options. An employee would have to tender all
options or none. This paper examines this program, exploring the
values offered compared to values perceived by employees, and the
hedging strategy used by JPMorgan Chase. It infers the
characteristics of the tendered options and employees who
tendered. The program was only moderately successful with 50% of
the employees tendering 55% of their options, and far less
successful than other programs. The paper finds that the
complexity of the program, the uncertainty of the amount offered,
and the requirement of tendering all options or none limited its
success. Nonetheless, the market was able to easily absorb the
high volume of short selling required to hedge the risk. Shortly
after the deal was closed, however, the volatility of Microsoft
stock fell from 30% to 15%, and JPMorgan Chase incurred a loss
estimated here and reported in the press to be nearly all of the
value of the options.
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"Employees' Perceived Value of Their Stock Option Holdings: How
Training Affects the Cost-Value Gap"
Author: ANNE M. FARRELL
University of Illinois at
Urbana-Champaign
Email: amf@uiuc.edu
Auth-Page: http://ssrn.com/author=74653
Contact: SUSAN D. KRISCHE
University of Illinois at
Urbana-Champaign - Department of Accountancy
Email: krische@uiuc.edu
Auth-Page: http://ssrn.com/author=249513
Co-Author: KAREN L. SEDATOLE
Eli Broad College of Business
Email: sedatole@bus.msu.edu
Auth-Page: http://ssrn.com/author=144793
Full Text: http://ssrn.com/abstract=906020
ABSTRACT: Analyzing a unique dataset from an equity compensation
service provider, we examine how employee stock option recipients
perceive the value of their option holdings and explore an
educational training program as a mechanism for improving
recipients' perceived value of their options. Results show most
recipients perceive their options as less valuable than the
corresponding Black-Scholes cost. Supplemental analyses provide
mixed evidence that risk aversion decreases perceived value, and
that wealth concentration and prior stock option experience
increase perceived value. Importantly, we find that a training
program which clearly articulates the economic fair value of
recipients' options increases both their perceived value and
their confidence in related decision-making.
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"Efficiency of Employee Stock Option Taxation and Disclosure"
Contact: MICHAEL NWOGUGU
Independent
Email: datagh@peoplepc.com
Auth-Page: http://ssrn.com/author=335757
Full Text: http://ssrn.com/abstract=903357
ABSTRACT: The paper analyzes some socio-legal, economic and
taxation issues pertaining to Employee Stock Options (ESOs), and
introduces new theories pertaining to optimal taxation of two
classes of ESOs (incentive and compensatory ESOs). The article
then develops the quantitative characteristics of optimal ESO
disclosure (which can also be applied to other securities and
disclosure problems), and explains why ESOs should not be
recorded in financial statements. The analysis in this article is
an implicit critique of all existing academic work on the
taxation and disclosure of employee stock options and incentives.
The major finding is that the current methods of accounting for
ESOs in the US, and the UK (and most developed countries) are not
accurate or efficient, and will increase the propensity for
fraud. ESOs present various problems in regulation, monitoring
and enforcement which have not been addresses properly by
existing legal and accounting systems. The current accounting
rules and proposed regulations for employee stock options and
incentive compensation are inadequate and need to be completely
re-formulated.
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"Transfer Pricing and Employee Stock Options"
Canadian Tax Journal, Vol. 53, No. 3, p. 607, 2005
Contact: AMIN MAWANI
York University - Department of
Accounting
Email: AMAWANI@SSB.YORKU.CA
Auth-Page: http://ssrn.com/author=111069
Co-Author: MARSHA L. REID
Deloitte & Touche, LLP
Auth-Page: http://ssrn.com/author=566820
Abstract: http://ssrn.com/abstract=871727
ABSTRACT: The arm's-length principle of transfer pricing requires
that transactions between related entities be undertaken at
prices and on terms and conditions that would exist between
entities dealing at arm's length. Applying the arm's-length
principle to employee stock options introduces practical and
theoretical issues that are difficult to reconcile and resolve.
Employers almost never grant options to acquire shares of
arm's-length corporations to their employees or to employees of
their subsidiaries, since to do so would not serve any incentive
alignment purpose. Further, employee stock options are difficult
to value because they are explicitly designed to be
non-marketable, non-transferable, non-exercisable before vesting,
and forfeitable if employment is terminated before vesting. The
resulting limited demand for and illiquidity of employee stock
options renders their valuation imprecise for all purposes - tax,
accounting, and economic. In this article, the authors examine
the arm's-length principle and its application to employee stock
options in cost-sharing arrangements and recharge agreements
between non-arm's-length entities. They also explore the
methodology and the timing of valuing such options for the
purposes of transfer pricing.
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"CEO Stock Options and Equity Risk Incentives"
Journal of Business Finance & Accounting, Vol. 33, No.
1-2, pp. 26-44, January/March 2006
Contact: MELISSA A. WILLIAMS
University of Houston, Clear Lake -
School of Business and Public Administration
Email: FNCMAW@LANGATE.GSU.EDU
Auth-Page: http://ssrn.com/author=239771
Co-Author: RAMESH P. RAO
Oklahoma State University -
Stillwater - Department of Finance
Email: rramesh@okstate.edu
Auth-Page: http://ssrn.com/author=32614
Full Text: http://ssrn.com/abstract=886398
ABSTRACT: We test the hypothesis that the risk incentive effects
of CEO stock option grants motivate managers to take on more risk
than they would otherwise. Using a sample of mergers we document
that the ratio of post- to pre-merger stock return variance is
positively related to the risk incentive effect of CEO stock
option compensation but this relationship is conditioned on firm
size, with firm size having a moderating effect on the risk
incentive effect of stock options. Using a broader time-series
cross-sectional sample of firms we find a strong positive
relationship between CEO risk incentive embedded in the stock
options and subsequent equity return volatility. As in the case
of the merger sample, this relationship is stronger for smaller
firms.
______________________________
"Stock Options and the Corporate Demand for Insurance"
Journal of Risk & Insurance, Vol. 73, No. 2, pp.
231-260, June 2006
Contact: LI-MING HAN
Washington State University
Email: han@wsu.edu
Auth-Page: http://ssrn.com/author=71521
Full Text: http://ssrn.com/abstract=904899
ABSTRACT: This article shows that a corporate manager compensated
in stock options makes corporate decisions to maximize stock
option value. Overinvestment is a consequence if risk increases
with investment. Facing the choice of hedging corporate risk with
forward contracts on a stock market index fund and insuring pure
risks the manager will choose the latter. Hedging with forwards
reduces weight in both tails of corporate payoff distribution and
thus reduces option value. Insuring pure risks reduces the weight
in the left tail where the options are out-of-the-money and
increases the weight in the right tail where the options are
in-the-money; the effect is an increase in the option value.
Insurance reduces the overinvestment problem but no level of
insurance coverage can reduce investment to that which maximizes
the shareholder value.