Title: Pricing of employee stock options: marketability does matter

Authors: John D. Finnerty

Addresses: Fordham University, 1790 Broadway, New York, NY 10019, USA

Abstract: Portfolio managers are rightly concerned about the marketability of the investments they include in their portfolios. Equity portfolio managers are also interested in how firms estimate the cost of the stock options they pay their employees. A recent attempt to develop market pricing of employee stock options (ESOs) illustrates the discount in price, and understatement of ESO expense, that will result when a financial instrument has little or no marketability. This paper investigates the auction pricing of an ESO tracking security called ESOARS and furnishes evidence of auction underpricing amounting to at least 25% in each auction. The paper shows that the underpricing can be largely explained when discounts for lack of marketability based on published marketability discount models are applied to ESO prices from well-accepted ESO valuation models. It quantifies how much lack of marketability can adversely affect a security's price.

Keywords: marketability discount; employee stock options; ESOs; valuation; auction pricing; employee stock ownership appreciation rights securities; ESOARS; portfolio management; auction underpricing; valuation models; securities pricing.

DOI: 10.1504/IJPAM.2012.049205

International Journal of Portfolio Analysis and Management, 2012 Vol.1 No.2, pp.179 - 205

Received: 31 May 2012
Accepted: 01 Jun 2012
Published online: 23 Aug 2014 *

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