Misvaluation of UK Executive Stock Options: Who Benefits?

This paper examines the effect of using different option valuation models to calculatethe fair market value of Executive Stock Options (ESOs) granted to executivedirectors of UK firms. Our key objective is to demonstrate empirically that somecompanies will have greater incentive and benefit from switching option valuationmodels under recent changes in the accounting treatment of ESOs in the UK. Thebasis of our analysis is the Black and Scholes (1973) model, as modified by Merton(1973), which we compare to three alternative valuation approaches. We find that theBlack-Scholes-Merton (BSM) model consistently overvalues short-term, out or at themoney options. We also observe that value companies that have recently experiencedbad performance and grant a substantial number of options have the highest incentiveto deviate from the BSM model.....