Modified Black-Scholes Model for Valuing Employee Stock Options with Constant Exit Rate: A Case Study of a Banking Company in Indonesia

Abstract

Employee Stock Options (ESO) are a form of compensation given to employees in the form of shares that can be purchased within a specified period. The ESO valuation uses the Black Scholes model, assuming employees remain employed until the vesting period is completed, excluding the employee’s departure from the company before the option rights are exercised. This study aims to determine the value of Employee Stock Options (ESO) by adding a constant exit rate factor. The data from this study are the closing price at BANK XYZ for the calculation of Volatility, for the risk-free interest rate from the Federal Reserve Bank of St. Louis used to calculate the option value using the Black-Scholes model, adjusted for the probability of continued employment (survival probability) obtained from various constant exit rate values. The results of the study using the constant exit rate produce a lower Employee Stock Option value than the calculation using the standard Black-Scholes model. The decline is greater with increasing maturity time because the employee’s probability of remaining employed at the company decreases. By applying a constant exit rate, the assessment results better reflect the real conditions compared to the Black-Scholes model, which does not consider the risk of employee departure from the company