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The value of being lucky : option backdating and non-diversifiable risk
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Henderson, Vicky, Sun, Jia and Whalley, A. Elizabeth (2021) The value of being lucky : option backdating and non-diversifiable risk. International Journal of Theoretical and Applied Finance, 24 (4). 2150023. doi:10.1142/S0219024921500230
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Official URL: https://doi.org/10.1142/S0219024921500230
Abstract
The practice of executives influencing their option compensation by setting a grant date retrospectively is known as backdating. Since executive stock options are usually granted at-the-money, selecting an advantageous grant date to coincide with a low stock price will be valuable to an executive. Empirical evidence shows that backdating of executive stock option grants was prevalent, particularly at firms with highly volatile stock prices. Executives who have the opportunity to backdate should take this into account in their valuation. We quantify the value to a risk averse executive of a lucky option grant with strike chosen to coincide with the lowest stock price of the month. We show the ex ante gain to risk averse executives from the ability to backdate increases with both risk aversion and with volatility, and is significant in magnitude. Our model involves valuing the embedded partial American lookback option in a utility indifference setting with key features of risk aversion, inability to diversify and early exercise.
| Item Type: | Journal Article | ||||||
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| Subjects: | H Social Sciences > HA Statistics H Social Sciences > HD Industries. Land use. Labor H Social Sciences > HG Finance Q Science > QA Mathematics |
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| Divisions: | Faculty of Science, Engineering and Medicine > Science > Statistics Faculty of Social Sciences > Warwick Business School |
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| Library of Congress Subject Headings (LCSH): | Nonlinear pricing, Nonlinear pricing -- Mathematical models, Prices -- Statistical methods, Options (Finance) -- Prices -- Mathematical models, Employee stock options -- Valuation -- Mathematical models | ||||||
| Journal or Publication Title: | International Journal of Theoretical and Applied Finance | ||||||
| Publisher: | World Scientific Publishing Co. Pte. Ltd. | ||||||
| ISSN: | 0219-0249 | ||||||
| Official Date: | 16 July 2021 | ||||||
| Dates: |
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| Volume: | 24 | ||||||
| Number: | 4 | ||||||
| Article Number: | 2150023 | ||||||
| DOI: | 10.1142/S0219024921500230 | ||||||
| Status: | Peer Reviewed | ||||||
| Publication Status: | Published | ||||||
| Reuse Statement (publisher, data, author rights): | Electronic version of an article published as International Journal of Theoretical and Applied Finance, 24 (4). 2150023. 2021 https://doi.org/10.1142/S0219024921500230 © [copyright World Scientific Publishing Company] https://www.worldscientific.com/worldscinet/ijtaf | ||||||
| Access rights to Published version: | Restricted or Subscription Access | ||||||
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