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The cost of granting executive stock options with strike prices adjusted by the cost of capital

Cheung, Joe and Corrado, Charles 2007, The cost of granting executive stock options with strike prices adjusted by the cost of capital, Pacific accounting review, vol. 19, no. 2, pp. 96-107, doi: 10.1108/01140580710819870.

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Title The cost of granting executive stock options with strike prices adjusted by the cost of capital
Author(s) Cheung, Joe
Corrado, Charles
Journal name Pacific accounting review
Volume number 19
Issue number 2
Start page 96
End page 107
Publisher Emerald Publishing Group
Place of publication Bingley, England
Publication date 2007-09
ISSN 0114-0582
2041-5494
Keyword(s) cost of capital
Europe
Monte Carlo methods
Summary Purpose – The purpose of this paper is to estimate the cost of granting executive stocks with strike prices adjusted by the cost of capital.

Design/methodology/approach – In the paper a Monte Carlo simulation approach developed in Longstaff and Schwartz is used in conjunction with the subjective valuation model developed in Ingersoll to value these executive stock options that are subject to performance hurdles.

Findings – The paper finds that standard European Black-Scholes-Merton option values overstate the true cost to the firm of granting these executive stock options. The option values also decrease with a higher dividend yield, a higher performance hurdle, a longer vesting period, and a shorter maturity.

Research limitations/implications – While the study in the paper is limited to the valuation of executive options, the methodology can be used to study incentive effects of executive stock options that have a performance hurdle.

Practical implications – The approach used in this paper to estimate the cost of granting executive stock options is a clear improvement over standard European option pricing approaches that often result in biased estimates.

Originality/value – This paper presents a first attempt to integrate the Ingersoll utility-theoretic model and the Longstaff and Schwartz least squares Monte Carlo algorithm to estimate the subjective value and the objective cost of executive stock options with a performance hurdle. This valuation approach will be useful in the study of other types of executive compensation.
Notes Reproduced with the kind permission of the copyright owner.
Language eng
DOI 10.1108/01140580710819870
Field of Research 150103 Financial Accounting
HERDC Research category C1.1 Refereed article in a scholarly journal
Copyright notice ©2007, Emerald Publishing Group
Persistent URL http://hdl.handle.net/10536/DRO/DU:30019566

Document type: Journal Article
Collections: School of Accounting, Economics and Finance
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Created: Thu, 17 Sep 2009, 09:55:04 EST by Liz Hau

Every reasonable effort has been made to ensure that permission has been obtained for items included in DRO. If you believe that your rights have been infringed by this repository, please contact drosupport@deakin.edu.au.