Misvaluation of UK executive stock options: who benefits?

Misvaluation of UK executive stock options: who benefits?
Document type
Working Paper
Author(s)
Lee, Edward; Lin, Yueh-Neng; Stathopoulos, Konstantinos
Publisher
Manchester Business School
Date of publication
1 July 2006
Series
University of Manchester Business School Working Papers. No. 473
Subject(s)
Trends: economic, social and technology trends affecting business
Collection
Business and management
Material type
Reports

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The key objective of this paper is to demonstrate empirically that some companies will have greater incentive and benefit from switching option valuation models under recent changes in the accounting treatment of ESOs in the UK. The basis 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 the Black-Scholes-Merton (BSM) model consistently overvalues short-term, out or at the money options. The authors also observe that value companies that have recently experienced bad performance and grant a substantial number of options have the highest incentive to deviate from the BSM model. These findings have implications not only to the companies' compensation and disclosure practices, but also to the further development of the relevant accounting standard.

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