TY - JOUR
T1 - Why do employees like to be paid with Options?
T2 - A multi-period prospect theory approach
AU - Sun, Lei
AU - Widdicks, Martin
N1 - Publisher Copyright:
© 2016 Elsevier B.V.
Copyright:
Copyright 2016 Elsevier B.V., All rights reserved.
PY - 2016/6/1
Y1 - 2016/6/1
N2 - The use of options as compensation for non-executive employees is a puzzle. Standard, rational, valuation models show that the cost of issuing options is larger than the value placed on the options by employees. Existing explanations for this puzzle are based upon static models that ignore the considerable dynamic aspects of employee stock option pricing and exercise behavior. We develop dynamic, multiperiod models of employee preferences considering risk aversion, loss aversion, overconfidence and probability weighting to test possible explanations of the use of employee stock options. We find that a cumulative prospect theory model generates scenarios where employees would prefer options to either cash or equity payments, and also optimally exercise their options early. This is the only model where options are preferred and also optimally exercised early.
AB - The use of options as compensation for non-executive employees is a puzzle. Standard, rational, valuation models show that the cost of issuing options is larger than the value placed on the options by employees. Existing explanations for this puzzle are based upon static models that ignore the considerable dynamic aspects of employee stock option pricing and exercise behavior. We develop dynamic, multiperiod models of employee preferences considering risk aversion, loss aversion, overconfidence and probability weighting to test possible explanations of the use of employee stock options. We find that a cumulative prospect theory model generates scenarios where employees would prefer options to either cash or equity payments, and also optimally exercise their options early. This is the only model where options are preferred and also optimally exercised early.
KW - Early exercise
KW - Employee stock options
KW - Overconfidence
KW - Prospect theory
UR - http://www.scopus.com/inward/record.url?scp=84964470547&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=84964470547&partnerID=8YFLogxK
U2 - 10.1016/j.jcorpfin.2016.03.002
DO - 10.1016/j.jcorpfin.2016.03.002
M3 - Article
AN - SCOPUS:84964470547
SN - 0929-1199
VL - 38
SP - 106
EP - 125
JO - Journal of Corporate Finance
JF - Journal of Corporate Finance
ER -