Early Exercise Behaviour in Performance-vested Stock Option Grants

Stock options in executive compensation packages influence risk taking behaviour through the sensitivities of executive wealth to stock price (delta) and stock return volatility (vega). In the context of performance-vested stock options (PVSOs), this paper carries out a sensitivity analysis of the PVSO value and incentives to examine the effect of considering the executive's early exercise behaviour that arises from risk aversion in the valuation framework. The results show the importance of taking into account voluntary early exercise in order to avoid the overvaluation of PVSO value and risk incentives, particularly when the PVSO is in-the-money. It will allow us to obtain correct conclusions about delta and vega and their effects on executive risk-taking behaviour.