We employ a certainty-equivalence framework to analyze the cost, value and pay/ performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive "executive value" lines, the risk-adjusted analogues to Black-Scholes lines. We show that distinguishing between "executive value" and "company cost" provides insight into many issues regarding stock option practice including: executive views about Black Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.
Advanced Topics in Equity Compensation Accounting
By Takis Makridis
In this required text for the CEP, published by the NCEO, author Takis Makridis selects a handful of valuation issues, one reporting issue and a hybrid of the above and subjects them to close scrutiny.