Valuation and incentive effects of hurdle rate executive stock options |
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Authors: | Joe Cheung Charles Corrado |
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Institution: | (1) Russell Investments, Level 11, ASB Bank Centre, 135 Albert Street, Auckland, New Zealand;(2) Department of Commerce, Massey University, Private Bag 102 904, Auckland, New Zealand |
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Abstract: | Traditional executive stock options are often criticized for inherently weak links between pay and performance. Hurdle rate
executive stock options represent a viable improvement. However, valuing these options presents extraordinary analytic difficulties.
With a constant dividend yield the strike price becomes a path-dependent function of the stock price and exact analytic valuation
is intractable. To solve this problem, we apply the Monte Carlo valuation approach developed by Longstaff and Schwartz (Rev
Financ Stud 4:113–147, 2001) to estimate the value of path-dependent American options. We also extend the methodology to incorporate
the theoretical framework by Ingersoll (J Bus 79:453–487, 2006) to permit subjective valuation influenced by an executive’s
risk aversion.
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Keywords: | Executive stock options Monte Carlo simulations Hurdle rate |
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