selling and hedging option positions can lead to early
exercise.
16 Brooks, Chance, and Cline (2005) argue that private
informationmayalsocauseearlyexercise:Themanagerswho
holdemployeeoptionsoftenhavetheinformationtomakea
judgment on whether their stock is overvalued. If it is
overvaluedintheirestimation,earlyexercisebecomesmore
likely.
17
Theempiricalevidenceisalsoclearlysupportiveoftheearly
exercisetheory.Inacomprehensivestudyof262,931option
exercises of employeeoptions between 1996 and 2003 by
U.S.companies,Brooks,Chance,andCline(2005)notethat
92.3 percent exercise early. On average, they find that
exercisetakesplace2.69yearsaftervesting,with4.71years
lefttoexpiration.Putanotherway,anemployeeoptionwitha
statedmaturityof 10 yearsisusuallyexercisedin5.29years.
Bettis, Bizjak, and Lemmon (2003) also find significant
variationinexercisepoliciesacrossfirms,withemployeesin
riskierfirmsexercising theiroptionsalmostone anda half
years earlier than employees in more stable firms.
18 Theimplicationsforoptionvaluationarestraightforward.
Usingthestatedmaturityinoptionpricingmodels,whichis
whatwedoformostmarketable options,willoverstatethe
value of employee options.
Which Stock Price?
Theanswer to this question mayseem obvious.Since the
stockistraded,andwecanobtainastockprice,itwouldseem
that we should be using the current stock price to value
options.However,wearevaluingtheseoptionstoarriveata