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Annals of Operations Research

, Volume 262, Issue 2, pp 335–359 | Cite as

Are employee stock option exercise decisions better explained through the prospect theory?

  • Hamza BahajiEmail author
S.I.: Financial Economics

Abstract

In this paper, we introduce a new framework for the analysis of employee stock options exercise decisions. We develop a distorted lattice model where the exercise decision obeys a policy that maximizes the expected value of the exercise outcomes under the Cumulative Prospect Theory. Using a large US dataset of exercise transactions, we show that our framework broadly outperforms the Expected Utility Theory framework in explaining empirical exercise decisions. Interestingly, our empirical estimates of probability weighting are consistent with those from the experimental literature. We argue that this analysis provides a unifying stream for thinking about issues related to the exercise and the valuation of stock options.

Keywords

Stock options Exercise decisions Cumulative Prospect Theory Option valuation 

JEL Classification

G13 G30 J33 M41 

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Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  1. 1.DRM- FinanceUniversity of Paris DauphineParis Cedex 16France

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