Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility

TLDR

The high cost of compiling employee stock option portfolio data hampers research on how options influence managerial incentives, accounting choices, financing decisions, and equity valuation. The authors propose an accurate, easily implemented method for estimating option portfolio value and its sensitivities to stock price and volatility using only the current year’s proxy statement or annual report. This method applies to both executive stock option portfolios and firm‑wide option plans, relying on data from the current year’s proxy or annual report to compute value and sensitivity metrics. In large samples of actual and simulated CEO option portfolios, the proxies capture more than 99% of the variation in value and sensitivities, with bias depending on portfolio characteristics but remaining above 95% across all subsamples.

Abstract

The costs associated with compiling data on employee stock option portfolios is a substantial obstacle in investigating the impact of stock options on managerial incentives, accounting choice, financing decisions, and the valuation of equity. We present an accurate method of estimating option portfolio value and the sensitivities of option portfolio value to stock price and stock‐return volatility that is easily implemented using data from only the current year’s proxy statement or annual report. This method can be applied to either executive stock option portfolios or to firm‐wide option plans. In broad samples of actual and simulated CEO option portfolios, we show that these proxies capture more than 99% of the variation in option portfolio value and sensitivities. Sensitivity analysis indicates that the degree of bias in these proxies varies with option portfolio characteristics, and is most severe in samples of CEOs with a large proportion of out‐of‐the‐money options. However, the proxies’ explanatory power remains above 95% in all subsamples.