Influence of Behavioral Factors on Early Exercise of Employee Stock Option: A Literature Review

Abstract

Employee Stock Option Plans (ESOPs) have gained prominence as a successful HR strategy that improves the employees’ performance and enables the company to have an economic and strategic advantage. However, the time at which employees decide to exercise their options determines the incentive that they derive from the stock options granted to them. It is one of the crucial financial decisions which can have immense implications for both employers and employees. According to the Black Scholes Model, an option's value is maximum when it is held until maturity. But most employees exercise their options early, which comes with a cost to both the employee and the company. It can be attributed to the fact that when faced with financial decisions the individuals do not always refer to complex finance models and formulas and make decisions rationally. Instead they resort to mental accounting and shortcuts leading to bounded rationality that can unconsciously impact their decision-making process. This paper explores the literature available on behavioral factors and biases that in addition to rational factors can affect the exercise of employee stock options.

Exercise decision of employee stock options: does Herding Bias influence the employees' decision?

“…Scarce literature is available on the interplay between Personality Traits, Herding Bias and the employees' decision to exercise ESOs. Arora and Arora (2022) have highlighted the need and importance of studying the relationship between the three to get a better understanding of how the employees exercise their stock options. This study is the first in itself to explore the impact of Personality Traits on the employee's decision as to when to exercise ESOs in the Asian region, especially in a price-sensitive country like India.…”