Are Employee Stock Option Exercise Decisions Better Explained through the Prospect Theory?
Bahaji, Hamza (2014-03), Are Employee Stock Option Exercise Decisions Better Explained through the Prospect Theory?, 63rd Annual Meeting of the Midwest Finance Association - MFA 2014 Annual Meeting, 2014-03, Orlando, FL, United States
TypeCommunication / Conférence
Conference title63rd Annual Meeting of the Midwest Finance Association - MFA 2014 Annual Meeting
Conference cityOrlando, FL
Conference countryUnited States
MetadataShow full item record
Dauphine Recherches en Management [DRM]
Abstract (EN)This research provides an alternative framework for the analysis of employee stock option exercise patterns. It develops a binomial model where the exercise decision obeys to a policy that maximizes the expected utility to a representative employee exhibiting preferences as described by the Cumulative Prospect Theory (CPT). Using a large database on exercise transactions in 12 US public corporations, I examined the performance of the model in predicting actual exercise patterns. Interestingly, the probability weighting coefficients yielded by the model calibration are consistent with those from the experimental literature. Further, the results suggest that the model outperforms the Expected Utility Theory-based model in predicting actual exercise decisions in the sample. These findings convey the main contribution of this paper: the strong ability of the CPT framework to explain employees exercise behavior. It therefore provides rationale for using this framework in order to get more relevant fair value estimates of stock options.
Subjects / KeywordsStock-options; Exercise behavior; Cumulative Prospect Theory; Fair value; Option valuation
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