An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Frank Hodge
University of Washington

Shiva Rajgopal
University of Washington

Terry Shevlin
University of Washington

Abstract: We investigate how current mid-level and future entry-level managers value stock options and restricted stock. We refer to our current and future manager groups collectively as “managers.” We supplement our manager data with a dozen interviews with senior executives. We find that managers, on average, systematically overvalue stock options relative to both the Black-Scholes (B-S) value and fair-value equivalent restricted stock grants. Thus, contrary to conventional economic thinking, many risk-averse agents do not appear to discount B-S values of options. Further, in valuing options, managers value quick vesting and extended expiration. Managers also extrapolate recently rising stock price trends to arrive at their subjective valuations of both options and restricted stock. In general, our results suggest that a combination of economic, behavioral and demographic factors explain managers’ subjective valuations of options and restricted stock.

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