Using sectoral indexes to discount the exercise price of employee stock options

Employee stock options (ESO) are instruments for compensating top management of corporations. In the literature they are described as a variable component of remuneration of a long-term character [Borkowska 2012, pp. 19-21]. There are six characteristic elements of ESO: a grant date, the ESO plan duration, employees entitled to receive options, vesting criteria, a vesting period and an exercise price. The article refers to the exercise price. The remuneration of employees is determined by the option intrinsic value, i.e. the difference between the current stock price and the exercise price. This difference affects the costs incurred by a company in relation to their incentive stock option plan. In this connection the exercise price of stock options needs to be analyzed.

The literature shows that usually the strike price is equal to the stock's market value at the time the option is granted. The purpose of this paper is to address several aspects of specifying the exercise price in ESO. The research shows how sector indexes can be used to discount it. Using sectoral indexes in determining the exercise price can partly limit the unreasonably high profits from the ESO. The literature does not provide readymade formulas for exercise prices based on specific variables. The aim of the research is to present and apply the exercise price formula in which sectoral indices are used  for discounting.

The data are from the Warsaw Stock Exchange and include those companies that revealed information concerning their incentive programs in 1999-2014. The relevant data come from annual reports, current reports, supervisory boards’ resolutions and press announcements.