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Title: Valuation of employee reload options in utility maximization framework
Authors: Kwok, Yue Kuen
Lau, Ka Wo
Keywords: Employee stock options
Utility maximization
Reload provision
Compensation incentives
Dead-weight loss
Issue Date: 2004
Abstract: The reload provision in an employee stock option is an option enhancement that allows the employee to pay the strike upon exercising the stock option using his owned stocks and to receive new 'reload' stock options. The usual Black-Scholes risk neutral valuation approach cannot be adopted as the pricing vehicle for employee stock options, due to the non-transferability of the ownership of the options and the restriction on short selling of the firm's stocks as hedging strategy. In this paper, we present a general utility maximization frmework to price non-tradeable employee stock options with reload provision. The risk aversion of the employee enters into the pricing model through the choice of the utility function. We examine how the value of the reload options to the employees are affected by the number of reloads outstanding, the risk aversion level and personal wealth. In particular, we explore how the reload provision may lower the difference between the cost of granting the option and the private option value and improve the compensation incentive of the option award.
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