by Susan P. Convery, Ph.D., CPA, CMA; Anne M. Farrell, Ph.D., CPA, CGMA; Susan D. Krische, Ph.D., CA; and Karen L. Sedatole, Ph.D.
- Employee stock options (ESOs) are often used to compensate employees other than top executives; however, ESOs are complex and not well understood by employees.
- In a study of 210 ESO recipients from five companies, we found employees often value their own options based on simple mental shortcuts, or anchors, that make subjectively judging value easy, but they typically misestimate the true value of ESOs. Options are exercised in the future, so a judgment that incorporates the time value of money leads to higher quality, and often higher dollar, estimates of their value.
- Using actual employees’ subjective estimates of the value of their ESO holdings, we show companies can influence subjective valuations of stock options by educating employees about valuation techniques that incorporate the time value of money. In an experiment using graduate business students who value hypothetical ESOs, we demonstrate that the type of training provided to employees matters.
- Companies that invest in ESO education programs will benefit from more efficient and effective use of ESOs as part of compensation packages in recruiting, retaining, and motivating employees.
- Financial planners can help both their clients who receive ESOs and the companies that issue ESOs to understand the underlying components of an option-pricing estimate.