Managerial discretion and the economic determinants of the disclosed volatility parameter for valuing ESOs

Eli Bartov (), Partha Mohanram () and Doron Nissim ()
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Eli Bartov: New York University
Partha Mohanram: Columbia University
Doron Nissim: Columbia University

Review of Accounting Studies, 2007, vol. 12, issue 1, No 6, 155-179

Abstract: Abstract This study investigates the determinants of the expected stock-price volatility assumption that firms use in estimating ESO values and thus option expense. We find that, consistent with the guidance of FAS 123, firms use both historical and implied volatility in deriving the expected volatility parameter. We also find, however, that the importance of each of the two variables in explaining disclosed volatility relates inversely to their values, which results in a reduction in expected volatility and thus option value. This can be interpreted as managers opportunistically use the discretion in estimating expected volatility afforded by FAS 123. Consistent with this, we find that managerial incentives or ability to understate option value play a key role in this behavior. Since discretion in estimating expected volatility is common to both FAS 123 and 123(R), our analysis has important implications for market participants as well as regulators.

Keywords: Executive stock options; Forward-looking information; SFAS No. 123; Implied volatility; M41; J33; G30; G13 (search for similar items in EconPapers)
Date: 2007
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DOI: 10.1007/s11142-006-9024-x

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