Employee Stock Option Valuations

Use Dates

Provide a valid underlying price.

Provide a valid Exercise price.

% p.a.

Provide a valid risk free rate.

% p.a.

Provide a valid dividend rate.

% p.a.

Provide a valid volatility rate.

% p.a.

Provide a valid exit rate.

Provide a valid Exercise Multiple.

The commonly used model for valuing employee share options can be found in the 2004 paper titled "How To Value Employee Stock Options" by John Hull and Alan White. In this paper, the authors presented an approach that effectively addresses the complexities involved in valuing employee stock options on their grant date.

This model is a modified version of the binomial tree method, which is widely employed for option valuations. Rather than delving into intricate details here, I recommend referring to the paper itself, as it provides a comprehensive explanation of how to implement it.

An employee stock option, commonly referred to as an ESO, is a benefit offered to employees by a company. It grants them the right to purchase a specific number of shares of the company's stock at a predetermined price, known as the exercise price or strike price, within a specified period of time.

ESOs serve as a means to incentivize and reward employees by providing them with the opportunity to participate in the company's success and share in its financial growth. When an employee exercises their stock option, they have the chance to buy the company's shares at a predetermined price, which is typically lower than the current market price. This allows employees to potentially profit from the increase in the company's stock value over time.

One of the key advantages of employee stock options is that they align the interests of employees with those of the company's shareholders. By giving employees a stake in the company, it encourages them to work towards its long-term success and fosters a sense of ownership and loyalty.

It's worth noting that employee stock options are usually subject to vesting, meaning that employees must fulfill certain requirements, such as a specific period of service, before they can exercise their options. This helps ensure that employees remain with the company and contribute to its growth over time.

Overall, employee stock options are a valuable tool in attracting, motivating, and retaining talented employees. They provide individuals with the opportunity to share in the company's prosperity and align their interests with the organization's long-term goals, ultimately benefiting both the employees and the company as a whole.

References:

  • Hull, J, and White, A: How to Value Employee Stock Options Financial Analysts Journal, Vol. 60, No. 1, January/February 2004, 114-119.

  • Hull, J, and White, A: Accounting for Employee Stock Options: A Practical Approach to Handling the Valuation Issues: Journal of Derivatives Accounting, Vol. 1, No. 1 (2004), pp 3-9.