Question

Can Black-Scholes formula be used in pricing executive stock options? Explain (2 marks)

Can Black-Scholes formula be used in pricing executive stock options? Explain

Homework Answers

Answer #1

No,as many companies are recognizing that the Black-Scholes formula is inappropriate for employee stock options (ESOs) and are moving toward lattice models for accounting or decision-making purposes. In the most influential of these models, the assumption is that employees exercise voluntarily when the stock price reaches a fixed multiple of the strike price, effectively introducing a "horizontal" exercise boundary into the lattice. In practice, however, employees make a trade-off between intrinsic value captured and the opportunity cost of time value forgone.

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