The Cost of Employee Stock Options

This paper determines the cost of employee stock options (ESOs) to shareholders. I present a pricing method that seeks to replicate the empirics of exercise and cancellation as good as possible. In a first step, an intensity-based pricing model of El Karoui and Martellini is adapted to the needs of ESOs. In a second step, I callibrate the model with a regression analysis of exercise rates from the empirical work of Heath, Huddart and Lang. The pricing model thus takes account for all effect captured in the regression. Seperate regresssions enable me to compare options for top executives with those for subordinates. I find no price differences. The model is also applied to test the precision of the fair value accounting method for ESOs, SFAS 123. Using my model als a reference, the SFAS method results in surprisingly accurate prices