Valuation and incentive effects of hurdle rate executive stock options

Abstract

Traditional executive stock options are often criticized for inherently weak links between pay and performance. Hurdle rate executive stock options represent a viable improvement. However, valuing these options presents extraordinary analytic difficulties. With a constant dividend yield the strike price becomes a path-dependent function of the stock price and exact analytic valuation is intractable. To solve this problem, we apply the Monte Carlo valuation approach developed by Longstaff and Schwartz (Rev Financ Stud 4:113-147, 2001) to estimate the value of path-dependent American options. We also extend the methodology to incorporate the theoretical framework by Ingersoll (J Bus 79:453-487, 2006) to permit subjective valuation influenced by an executive's risk aversion.

Employee stock options with performance conditions: do commonly used valuation heuristics work?

“…Lastly, we are aware of two papers that model the exercise decision in a utility framework. Cheung and Corrado () incorporate the theoretical utility exercise framework from Ingersoll () in a simulation approach. They use this approach to value employee options where the strike is increased with time to maturity.…”