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RFS Advance Access originally published online on December 11, 2007
Review of Financial Studies 2008 21(2):683-724; doi:10.1093/rfs/hhm065
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© The Author 2007. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org

Analytic Pricing of Employee Stock Options

Jaksa Cvitanic
Division of Humanities and Social Sciences, California Institute of Technology

Zvi Wiener
School of Business Administration, The Hebrew University of Jerusalem

Fernando Zapatero
Marshall School of Business, University of Southern California

Contact information: Zvi Wiener (corresponding author), School of Business Administration, The Hebrew University of Jerusalem, Mount Scopus, Jerusalem 91905, Israel; e-mail: mswiener{at}mscc.huji.ac.il; Jaksa Cvitanic, California Institute of Technology, M/C 228-77, 1200 E. California Blvd., Pasadena, CA 91125; e-mail: cvitanic{at}hss.caltech.edu; Fernando Zapatero, FBE, Marshall School of Business, USC, Los Angeles, CA 90089-1427, e-mail: fzapatero{at}marshall.usc.edu.


  Abstract

We introduce a model that captures the main properties that characterize employee stock options (ESO). We discuss the likelihood of early voluntary ESO exercise, and the obligation to exercise immediately if the employee leaves the firm, except if this happens before options are vested, in which case the options are forfeited. We derive an analytic formula for the price of the ESO and in a case study compare it to alternative methods.

Jaksa Cvitanic research has been supported in part by NSF grants DMS 04-03575 and DMS 06-31366. Zvi Wiener wishes to thank the Krueger fund, the Caesarea Center for Capital Markets, IDC Herzliya, and ISF grant 413/05 for financial support. We are grateful to Kevin Murphy for very useful preliminary conversations, and to Tsahi Melamed and Patrick Mulligan for pointing out a typo in the formulas. Research assistance from Melissa Maisch and Moran Ofir is gratefully acknowledged. Previous versions of this paper have been presented in seminars at CEMFI, Hebrew University, and the University of Minnesota. Existing errors are our sole responsibility.


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