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Heterogeneous beliefs and employee stock options

Jun Wang and Ge Zhang
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Jun Wang: Baruch College
Ge Zhang: University of New Orleans

No 2003-14, Working Papers from University of New Orleans, Department of Economics and Finance

Abstract: This paper uses a market valuation model to explore why firms grant employee stock options. When insider managers and outside investors have different opinions about the future prospects of the firm, employee stock options can be used to capture future investor overvaluation and to save employee compensation costs. Options can enhance the stock value for existing shareholders if the difference in opinion is highly volatile. The equilibrium option grant is positively correlated with both the perception error of investors, and the volatility of this error, as well as the correlation between investors 19 error and firm fundamental value. The model provides implications on the cross-sectional differences in option grants, and these implications can be examined empirically. 1 Introduction An employee stock option is an agreement between a firm and its employees under which the employees can buy a specified number of shares of stock at a specified price. Over the past decade, the use of employee stock options has been rising.

Keywords: Stock options; Market valuation (search for similar items in EconPapers)
JEL-codes: G32 M52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk
Date: 2003-10-15
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