A General Framework for Evaluating Executive Stock Options∗

Motivated by recent recommendations by both European and American accounting standards boards that executive stock options be expensed in firms’ statements, we provide an analytical and flexible framework for their evaluation. Our approach takes into account the vesting period, American style, resetting and reloading provisions that are features of many options programs, and also considers the trading restriction on executives. We identify a recursive structure in the stream of options that are granted to the executive over the course of her employment. By exploiting this, we are able to obtain a near-explicit formula for the option value. This enables us to discuss the joint effects of the different features on the exercising strategies and firms’ granting cost. Especially, we highlight some significant interactions among these features. JEL classification: G13; J33; G30; M41 ∗We are grateful to Patrick Bolton, Markus Brunnermeier, Jennifer Carpenter, Tom Knox, Mete Soner, Xavier Vives (editor) and three anonymous referees, as well as seminar participants at Carnegie Mellon University, Columbia University, MIT, Princeton University, University of Rochester, the Blaise Pascal Conference on Financial Modelling in Paris, and the 2004 ASSA Meetings in San Diego for helpful discussions and comments. †ORFE Department and Bendheim Center for Finance, Princeton University, Princeton, NJ 08540. E-mail: [email protected] ‡Corresponding author. Department of Economics and Bendheim Center for Finance, Princeton University, Princeton, NJ 08540. E-mail: [email protected]; Phone: (609) 258-0282.