Taxation and the value of employee stock options

Abstract

Purpose

This paper aims to derive firm value implications for various kinds of employee stock options (ESOs) in a framework that considers uncertainty, non‐diversification and the US statutory tax treatment.

Design/methodology/approach

The authors extend the analysis of ESOs from the case of perfect capital markets to two cases of imperfect capital markets using the Benninga‐Helmantel‐Sarig framework.

Findings

It is found that ESOs are inferior to cash compensation and that the degree of option inferiority depends on employee diversification. In addition, incentive stock options (ISOs) are generally inferior to non‐qualified stock options (NSOs). This relative profitability of the NSO versus ISO increases as market imperfections are added. The authors also find that in general firm hedging of ESOs is suboptimal.

Originality/value

The paper highlights the firm value of employee stock options.

Citation

Abudy, M. and Benninga, S. (2011), "Taxation and the value of employee stock options", International Journal of Managerial Finance, Vol. 7 No. 1, pp. 9-37. https://doi.org/10.1108/17439131111108982