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Many companies are recognizing that the Black-Scholes formula is inappropriate for employee stock options (ESOs) and are moving toward lattice models for accounting or decision-making purposes. In the most influential of these models, the assumption is that employees exercise voluntarily when the stock price reaches a fixed multiple of the strike price, effectively introducing a "horizontal" exercise boundary into the lattice. In practice, however, employees make a trade-off between intrinsic value captured and the opportunity cost of time value forgone. The model proposed here explicitly recognizes and accounts for this reality and is intuitively appealing, easily implemented, and compliant with U.S. accounting standards.


Required Publisher Statement
© Chartered Financial Analysts Institute. Final version published as: Brisley, N. , & Anderson, C. K. (2008). Employee stock option valuation with an early exercise boundary. Financial Analysts Journal, 64(5), 88-100. Reprinted with permission. All rights reserved.