Employee Stock Option Valuation with Earnings-Based Vesting Condition

Patel, Kavir

Employee Stock Option Valuation with Earnings-Based Vesting Condition

Master Thesis

2018

Publisher

University of Cape Town

Department

African Institute of Financial Markets and Risk Management

Faculty

Faculty of Commerce

Abstract

The valuation of employee stock options has become a key requirement due to the rapid growth in the use of these options as a means of employee compensation. IFRS 2 Share-based Payment stipulates that these instruments must be valued and expensed on the date the awards are issued. This dissertation aims to value an employee stock option, in a case where both the equity and vesting (performance) condition are based on a reported earnings process. The equity dependency on earnings stems from the fact that we are primarily concerned with the valuation of employee stock options that are issued by a private firm. We implement a capital structure framework provided by Goldstein, Ju and Leland (2001). In this framework, equity and debt are derived from an underlying EBIT process that is governed by a geometric Brownian motion. The model also accounts for taxation and bankruptcy. The research aim is addressed by incorporating the capital structure model into our employee stock option pricing framework.

Keywords

Mathematical Finance

Reference:

Collections

Masters

Full item page